Individual retirement arrangements, or IRAs, offer an easy way to sock away money for retirement. The biggest decision you’ll need to make is whether to open a Roth IRA or a traditional IRA. The right answer depends on your age and your individual tax situation. Either way, the money you save now will grow over the years to help keep you a be little more secure when you are no longer earning a paycheck.
If you had taxable income, or if you didn’t work but are married to someone who had taxable income, you can open an IRA. You can open an IRA, either traditional or Roth, whether or not you’re enrolled in a retirement plan at work, but you may not be able to take a tax deduction for your contributions for a traditional IRA if you’re also covered by your employer’s retirement plan.
To open a Roth IRA, your adjusted gross income must be less than a maximum amount set by the IRS. In 2011 the maximum was $179,000 for a person married and filing jointly or a qualified widow or widower. For single filers, those claiming head of household status and those married but filing separately and who didn’t live without their spouses during the year, the limit is $122,000. If you’re married but filing separately and you did live with your spouse during the year, you can’t open a Roth IRA if you had an adjusted gross income of more than $10,000.
With a traditional IRA, you can deduct your contributions from your taxable income regardless of whether you itemize. In 2011, if you weren’t covered by a retirement plan at work, you could contribute up to $5,000 to your traditional IRA. If your employer offers a retirement plan, the amount you can claim is reduced if you make over $56,000 if you’re single or filing as head of household, and to $90,000 if you’re married and filing jointly. If you make over $66,000 and you’re single, or more than $110,000 if you’re married, you can’t take a deduction for your IRA if your employer offers a retirement plan. You don’t pay taxes on the money in your IRA until you take out the funds once you reach age 59 1/2. At that time, you’ll be taxed at the same rate as your regular income for the money you withdraw. If you withdraw funds before age 59 1/2, you’ll pay taxes and a 10 percent penalty for early withdrawal.
You pay taxes now on the money you use to fund a Roth IRA, but the money grows in the account tax-free. When you take the money out, you pay taxes on neither the contributions nor the earnings. You receive no tax deduction for the money you put into a Roth IRA.
The IRS limits the amount you can add to the account each year. In 2012 you could contribute up to $5,000, or $6,000 if you were over 55. If you have a retirement plan at work and your income is over the limit for realizing a tax deduction for traditional IRA savings, a Roth IRA offers another avenue to save for retirement.
Choosing an IRA
If you’re young and can afford to pay taxes on your contributions now, a Roth IRA makes sense. According to Bankrate.com, if you save just $2,000 a year starting at age 25, you’ll have $560,000 by the time you’re 65, assuming a growth rate of 8 percent. With a Roth IRA your account grows tax-free. Continuing the example, your $80,000 in contributions over 40 years would be made with income already taxed, but you never pay taxes on the $480,000 in interest the account would earn. If you’re closer to retirement age, or you can’t afford to give up the tax deduction of a traditional IRA, a traditional IRA would be the better choice.
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