An IRA is an acronym for Individual Retirement Account. This is a retirement account separate and distinct from an employer retirement plan. You might be able to fund an IRA in addition to participating in your employer plan. The money you contribute to the account can be invested and grows over time. The growth is tax free while it is inside of the IRA.
There are two main types of IRAs -Traditional and Roth. Roth IRA contributions are made with money that has been taxed, and Traditional IRA contributions are made with pre-tax money. As a result, withdrawals from a Roth IRA are not taxed as income when you use them in retirement, and Traditional IRA withdrawals are taxed. Another difference between the two is that Traditional IRAs require a minimum distribution by April 1 of the year you turn 70 ½ years old – even if you don’t want to receive distributions yet. Roth IRAs do not require a minimum distribution at any point.
The contribution limits for each account are also important to know. In 2019, you can contribute up to $6,000 per year to both your Roth and Traditional IRA accounts ($7,000 if you are age 50 or older).
Tax advantages of an IRA
Both Roth and Traditional IRA contributions have their own unique tax advantages.
If you contribute money to a Traditional IRA, you qualify for a tax break that year. The money you contribute reduces your taxable income for that year. However, you do have to pay income taxes on that money when you begin taking distributions from that account.
If you contribute money to a Roth IRA, you qualify for a tax break at the time you start taking distributions. Since that money is post-tax money, you will not have to pay it again. If you’re taking a qualified distribution, the earnings you’ve made will not be taxable either.