Planning for retirement can be complicated. Since it seems far away, new couples frequently neglect to plan for it, but beginning early is the secret to a large retirement fund later on. Retirement accounts include several types of IRA accounts. Understanding the differences between retirement accounts is an important step in selecting the right type of savings and investment account for you. Even more important, it can keep you from making expensive mistakes along the way.
An IRA, or Individual Retirement Account, is a tax-advantaged way to save and invest for retirement. IRAs follow rules and regulations issued by the Internal Revenue Service. In all IRAs, money within the account grows tax deferred until withdrawal. This means that no capital gains taxes or taxes on interest accrued are due each year.
Traditional IRA Basics
A traditional IRA offers qualified taxpayers an income tax deduction for contributions made to the account. Taxpayers who do not qualify for the deduction can still make nondeductible contributions to an IRA, up to $5,000 per year. These nondeductible contributions must be documented fully, because no additional taxes should be paid on them.
401(k) Account Basics
Many people get their start investing for retirement via a 401(k) plan or other employer-sponsored retirement plan at work. Typically, contributions to these plans are made with pretax dollars. All growth within the plans occurs on a tax-deferred basis. A 401(k) or other retirement plan may be transferred into an IRA account under certain circumstances, usually when the employee changes employers.
Transferring a retirement account into an IRA account is known as a rollover. A rollover is a special type of transfer that is tax-free. In the case of certain employer-sponsored retirement plans, like a 401(k), that money can be rolled back into another 401(k) at a later date. However, only money from a previous retirement plan may be transferred in this way. A rollover IRA is the same as a traditional IRA, except that only funds rolled over from a previous retirement plan are held in the account. By segregating the monies in this way, a rollover IRA ensures that the funds can be rolled to a 401(k) plan should the opportunity ever arise.
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