What’s an IRA?
IRA stands for Individual Retirement Arrangement. They are a special type of investment account available in the U.S. that offer special tax benefits depending on which one you invest in. Whether you have a Traditional IRA or a Roth IRA (or both), there are limits on how much money you can put into them on a yearly basis. You can check out our IRA calculator below to find out what your personal limits and deductions might be, which largely depends on your age, your income, and your tax filing status.
A traditional IRA is in general, tax deductible. This means that you’re investing with pre-tax money. For example, if you make $40,000 this year and contribute the max amount of $5,500 to your traditional IRA, your taxable income gets lowered to $34,500. Taxes on the money you’ve invested into a Traditional IRA are not paid until you’re ready to withdraw it at retirement age. However, if you’re already contributing to a retirement plan at work you won’t be able to get a tax deduction for your Traditional IRA contribution.
A Roth IRA is funded with post-tax money. The money you put in here will be a part of your normal income taxes, which means that you get no tax deduction. The benefit of this type of account is that when you’re ready to retire, you won’t owe taxes when you withdraw the money.
You might choose to invest in a Roth IRA over a Traditional IRA if you’re young and are in a lower tax bracket- but you think that you’ll be making more money later on in life. If that’s the case, by then you’ll be in a higher tax bracket and will benefit greatly from not having to pay a large amount in taxes for withdrawing the account. Another reason you might invest in a Roth is if you think taxes will increase significantly by the time you’re of retirement age.
Choosing an IRA (or two!)
Keep in mind that no matter which type of account or combination of both that you go with, the maximum you can contribute on an annual basis between the both of them is usually $5500 (or $6500 if you’re 50 years old). With a Roth IRA in particular, you might only be able to contribute a reduced amount- or even nothing at all if your income is high enough.
To see all rules regarding IRAs, check out the IRS’ page on them here. We’ve provided you with a convenient estimation tool to help guide you in understanding your personal contribution limits and deductions- though it should not be taken as tax advice. Check it out below!