Traditional and Roth Individual Retirement Accounts, or IRAs, are investment vehicles designed to help you save for retirement. For young investors, the accounts represent an opportunity to begin to build wealth in order to accumulate a comfortable savings resource for retirement. Both traditional and Roth IRAs offer tax advantages. IRAs typically can be purchased from banks, life insurance companies, mutual funds and stockbrokers.
Tax-Free Growth vs. Tax-Deferred Growth
A major benefit of both traditional and Roth IRAs that makes them attractive for young investors is that the funds in the accounts are not taxed while they remain in the accounts, including all the gains and distributions from the securities held in the IRAs. This allows the accounts to grow unhindered by taxes for decades if you open an IRA account when you are in your 20s or 30s. However, traditional IRAs require you to pay taxes on your withdrawals, making the growth tax-deferred. A Roth IRA does not require you to pay taxes on your withdrawals in retirement, making the growth truly tax-free.
A traditional IRA can be helpful for young investors because contributions to the account can be tax-deductible, as long as you meet one of a series of qualifications. You qualify for a deductible traditional IRA if you do not have a retirement plan at work, if you have a retirement plan at work but your individual income is below $68,000 or household income is below $112,000, or if your spouse is eligible for a retirement plan but you aren't and your joint income is below $183,000. Contributions to Roth IRAs are never tax-deductible.
The Roth IRA provides a more flexible option for young investors who might want access to the funds in their account. If you withdraw money from a traditional IRA before you turn 59 1/2, you will pay a tax penalty of 10 percent on the withdrawal in addition to tax obligations. Similarly, if you withdraw money from the investment earnings accrued in your Roth IRA account, then you will face that same 10-percent penalty. The difference is that you have the freedom to withdraw funds from the contributions that you have made to a Roth IRA without incurring a penalty. This gives you access to a portion of your Roth IRA funds in the event that you need the money before your later years.
Both traditional and Roth IRAs offer qualifying reasons that enable you to withdraw money without taking the 10-percent tax penalty. One qualifying event that could particularly help a young investor is using the funds to pay expenses for you or a spouse to take college courses, such as if you enroll in graduate school. College expenses for children and grandchildren also qualify. Another qualifying event common for young investors is the purchase of a first home. Withdrawals up to $10,000 from a traditional or Roth IRA are allowed for a first home. Finally, a sudden disability or medical expenses that exceed 7.5 percent of your adjusted gross income would enable penalty-free withdrawals from a traditional or Roth IRA.