What an IRA is for
An individual retirement account is one you open yourself at a brokerage, independent of any employer. It matters to three groups: people with no workplace plan, people who have already captured their employer match and want cheaper or better investments, and people rolling over an old 401(k). You need earned income to contribute, and you may put in the annual limit or your earnings for the year, whichever is less. The IRS adjusts that limit periodically and publishes it. Contributions for a given tax year are allowed until the filing deadline the following April.
How the rules differ in practice
With a Roth, qualified withdrawals after age fifty-nine and a half are entirely tax-free, provided the account has been open five years. With a traditional IRA, every dollar withdrawn is taxed as ordinary income. Two restrictions decide the matter for many people. Eligibility to contribute directly to a Roth phases out above an income threshold. The deduction for a traditional IRA phases out at a much lower income if you or your spouse are covered by a retirement plan at work, and a traditional IRA without the deduction has little to recommend it. Both sets of thresholds change annually, so check the current figures on the IRS website before contributing.
Flexibility
The Roth has an advantage that matters when you are young: your contributions, though not the earnings, can be withdrawn at any time without tax or penalty. That makes a Roth less frightening to fund when savings are thin, although raiding it should remain a last resort, since the money cannot be put back beyond the normal annual limit. Early withdrawals of earnings, or of anything from a traditional IRA, generally bring income tax plus a ten percent penalty. A traditional IRA also forces required minimum withdrawals starting in your seventies, and a Roth never does during your lifetime.
Opening and funding one
- Open the account online at a low-cost brokerage, which takes about fifteen minutes.
- Link your checking account and set up an automatic monthly contribution.
- Choose an investment, such as a broad index fund or a target-date fund, because cash left sitting in an IRA stays uninvested and earns next to nothing.
- Leave it alone.
Step three is the costly mistake. Many people discover years later that their contributions were never invested.
Note You can fund a 401(k) and an IRA in the same year, and the contribution limits are separate. The usual order is the workplace match first, then the IRA, then back to the 401(k).
