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Understanding IRAs

Individual retirement accounts(IRAs) are personal retirement plans. You must earn income to contribute, and will usually build the plan over several decades.

Roth vs Traditional

There are two types of IRAs: a traditional IRA and a Roth IRA. The main difference between them is when you pay taxes.

A traditional IRA is tax deferred. This means that you can contribute money before it's taxed, and you don't owe taxes on those contributions or your earnings until you withdraw the money. The amount of interest you pay is based on how much you made that year. So if you think your tax rate is going to be lower when you retire, a traditional IRA can save you money.

A Roth IRA is not tax deferred so you owe taxes when you contribute the money to the account. But that means you won't have to worry about paying them later and your contribution can grow tax-free. If you think you will be taxed at a higher percent when you retire, then it might be worth paying the taxes now. Though, you should know that withdrawals are only tax-free if your account has been open at least five years and you’re at least 59 and a half years old.

Which IRA is for You?

The simple answer is, if you think you’ll be in a higher tax bracket when you retire, a Roth IRA is the better investment. If you will stay the same or lower, then a traditional IRA may be better.

But that is just a guideline. The goal is to collect the most money you can when you retire, and in order to maximize your IRA, you'll need to make sure you know all the laws, limits, and qualifications. These will change over time, but you can always go to your financial institution for advice or seek help from a financial advisor.

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Withdrawing the Money

If you want to make a withdrawal before you're 59 and a half, you'll have to pay a 10% tax penalty. On the other hand, you must begin to make withdrawals when you turn 70 and a half with a traditional IRA. If you have a Roth IRA, you’re never required to make withdrawals.

Contribution Limits

The only requirement for opening an IRA is having earned income. Your total annual contribution is limited to $6,000 for 2022, whether you put it all in one account or divide it between a traditional IRA and a Roth.

Any amount of income you earn qualifies, and you can contribute as much as you want up to the annual cap. But you can’t contribute more than you earn. For example, if you earn $1,800 in a year, that’s how much you can put in. And whether you earn $5,500 or $350,000, the top limit is the same.

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It's Your Account

After you turn 18, it’s easy to open an IRA. All you do is fill out a relatively simple application provided by your bank or credit union,, mutual fund company, brokerage firm, or other financial institution you choose to be a custodian (responsible for watching over) of your account.

Because IRAs are self directed, you decide how to invest the money. You’re responsible for following the rules that govern the accounts. Basically, that means you have to make sure you’re not putting in too much money and making approved investments.

IRAs are complicated, but you don’t have to be an expert to use them. They can be automated to take a little out of each paycheck and will continue to grow even if you don’t understand how they work. Whether you go Roth, Traditional, or both, the only questionable choice is not to invest at all.