Choosing the Right IRAIRA Basics

IRAs are useful tools for retirement. Choosing the right IRA may seem like a tough task, but it really isn't. The most common dilemma is whether to invest in a Roth IRA or a Traditional IRA. The answer depends on what you percieve your future tax rate to be.

First we'll look at some IRA terminology, then we'll look at the advantages and disadvantages of a using a Roth IRA vs. a Traditional IRA.

 

IRA Basics


An IRA is a tax deferred account.

Taxation is deferred until you are at least 59 and 1/2 years old.

A Roth IRA is different from a traditional IRA because it is taxed upon contribution, whereas a Traditional IRA is taxed upon withdrawal.

When an IRA is inherited it becomes a Decedent IRA. A Decedent IRA is an IRA established by an inheritor to hold the assets that they inherited.

An Educational IRA is an IRA for the educational expenses of a minor. Contributions made to an educational IRA are not tax deductable.

 

Roth vs Traditional IRAs


Most people will see a drop in their tax rate after retirement. This is due to lower income. If this is your situation, then a Traditional IRA would probably be right for you. You will defer your taxation on any money that you put into the IRA and will realize this taxation at a lower tax rate when you are older and earning less money.

If you anticipate a higher tax rate after retirement then a Roth IRA is probably the better choice. If, for example, you've saved so much for retirement that your income will actually be higher after retirement. If this is your situation, then you should face taxation earlier at the lower rate. Another benefit of the Roth IRA is that you can give the IRA to your heirs and they won't have to pay taxes on withdrawals.

One other consideration in the Roth IRA vs Traditional IRA debate is whether the government will change its tax rate in the future. If you believe that the government will raise taxes in the future, then it would make sense to face the tax burden before these future tax increases.

 

Multiple IRAs


You can have as many IRAs as you want. However, you can only contribute 5000 per year into all of your IRAs. So if you have 5 IRAs then you could only contribute 1000 to each one.

 

Roth IRA Home Purchase


You can use 10,000 dollars of your IRA to buy a house if you're a first time homebuyer, and you will not incure the 10% early withdrawal penalty. However, there are many regulations you must follow.

 

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