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Traditional IRA and Roth IRA Tax Benefits

If you are looking for a tax-deferred or tax-free investment tool to use within your retirement plan, IRAs may be the right choice for you.

The opening of an IRA account is easy. Such accounts provide you with the opportunity of trading stocks. However, there are certain contribution limits you should keep up to.

Two reasons are worth noting among the many advantages that IRAs present:

  • Good retirement saving tool
  • Provide tax advantages for your investments

IRA Types

Basically there are two types of IRAs - Traditional IRAs and Roth IRAs. There are many other types of IRAs, but these two are the most often used ones in retirement plans.

As it was mentioned above you are not provided with limitless possibility of contributing to you IRA account. Each year the IRS sets the limits up to which you are allowed to contribute. These limits are determined with consideration on the age of the individual. For instance, if you are above the age of 50 you are allowed to contribute more.

Traditional IRAs Tax Benefits

For tax purposes the contributions you make to your IRA account are subtracted from the gross income you earn. As a result, you subtract the amount you are willing and able to contribute to your IRA account before any taxes have been deducted. Thus, you end up paying fewer taxes.

The possibility of not deducting your IRA exists in case your spouse has a company-sponsored retirement plan (e.g. 401k plan). However, the deductibility of your IRA depends on the amount of your income.

Another benefit of IRAs is that the growth of your assets within your account is deferred from taxes. This is so until you decide to retrieve money from the account. By law you are not allowed to withdraw money from an IRA account until you reach the age of 59 1/2. If, however, you need money before that age you will be subject to a 10% penalty. The withdrawals you make from your account are subject to taxation, which is equal to your current rate of income tax.

Even though active trading within an IRA account is not recommended, you can still do it at your own discretion without incurring any capital gains taxes. However, you will have to pay commission fees.

Roth IRAs Benefits

Roth IRAs differ from traditional IRAs in tax terms in this that withdrawals from your account are freed from taxes. The funding of a Roth IRA account is done by after-tax dollars. Thus your contributions have been taxed once and your withdrawals will not be taxed. Another difference between the Roth IRAs and their traditional counterparts is that the earnings within the first are free from taxes.

Roth IRAs are suitable for those investors, who will fall in a higher tax bracket after retirement.

There are also limits to the contributions you can make to your Roth IRA account, which are the same as the traditional IRAs. There are several rules you should abide to, so call your broker to inform yourself about them.

IRA Account Opening

The earlier you open your IRA account the better. You can do it at any time during the year. However, it is recommended to open an IRA account before you file your taxes.

The early start is recommended since your assets will have more time to grow tax-deferred and tax-free. Thus, you will have more resources to withdraw when the time comes.

Finally, no matter which type of IRA you select, do it as soon as possible. IRAs represent a great component of your retirement plan, since by including them you will take advantage of the many tax advantages they provide.

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