Payday Loans

Understanding Credit

Personal Finance

Family Finance

Personal Retirement

Determining Which IRA is Right For You

An IRA or Individual Retirement Account is a savings plan for individuals saving money for retirement. One of the biggest attractions of an IRA is that it offers certain tax advantages as an incentive to get individuals to contribute to it.

IRA's can be opened by any individual with a taxable income. Individuals can contribute to their IRA up to certain maximum annual allowable limits set by law.

The contributions that an individual makes into an IRA, and any earnings on those contributions, are typically allowed to accumulate tax-free. It is only when a withdrawal is made that the amount which is withdrawn is taxed. Any withdrawals that are made from an IRA before the age of 59 and a half are assessed a 10% early withdrawal penalty in addition to being assessed income taxes.

Though there are five different types of IRA's, by far the two most popular ones are the Traditional IRA and the Roth IRA.

Determining which IRA is right for you can be a tricky proposition and requires a careful analysis of the tax benefits and the tax implications of each plan. A lot depends on your taxable income, age, family and filing status.

The biggest benefit of the Traditional IRA is that contributions that are made into it during the year are tax deductible in the year the contribution is made. So an individual who makes a contribution of $3,000 in 2009 would be able to deduct that amount from his or her taxable income for that year. The contributions and earnings accumulate tax free until the time it is withdrawn at which point the amount is taxed as ordinary income. The maximum allowable contribution limit for a Traditional IRA in 2009 is $5,000 though those who are 50-years and older can contribute up to $6,000.

A Roth IRA on the other hand offers no immediate tax benefit. A person who contributes to a Roth IRA will not be able to deduct that amount from the taxable wages for that year. However, one huge advantage is that all eligible withdrawals are completely tax free. Every cent of the contributions that are made into a Roth IRA, along with all the earnings it accumulates is tax free.

In determining which IRA is right for you, a Roth IRA might appear to be the obvious choice because of the tax-free nature of the withdrawals. For many it would appear to be the better choice for sheltering their savings from taxes.

However, there are some other factors that need to be taken into consideration as well before determining which IRA is right for you.

The immediate tax benefits that a Traditional IRA offers can be particularly useful for those who are in a higher tax bracket because it allows them to deduct their contributions and thereby reduce their taxable income. The amount that is saved in taxes annually in this manner can be reinvested in an interest-earning account. Over the years this amount could help offset at least some of the money they would lose in taxes when making withdrawals from a Traditional IRA.

Many people also tend to fall into a lower tax bracket when they retire. So the amount they would pay in taxes on their IRA withdrawals in future would be lower than what they would pay under their current tax status. For individuals who expect to be in this situation a Traditional IRA might be worth considering because it helps them avoid paying higher taxes right away.

On the other hand, a Traditional IRA allows contributions only from those who are under 70 and a half years of age while a Roth IRA does not have any such limitation. Individuals can also get penalized if they do not start withdrawing funds from their Traditional IRAs within a specific time period. There are no such penalties associated with Roth IRAs.