Over the past week I’ve discussed retirement a bit. It’s wise to establish your savings now and continue saving through the years. After all compound interest over 40 or more years can really add up even if the annual contributions are small.
Some readers may find their employer does not offer a 401k fund, or any other for that matter. This certainly holds the disadvantage of not obtaining an employers matching contribution but it certainly doesn’t mean you should not save. According to the IRS “Starting a retirement savings plan can be easier than most people think. What’s more, there are a number of retirement programs that provide tax advantages to both employers and employees.” Here is a brief overview two of the IRA of the account types you can setup if your employer does not offer a retirement fund.
There are several types of IRAs: Traditional IRAs, Roth IRAs, SIMPLE IRAs and SEP IRAs. We will address Traditional and Roth since they can be established by an individual and are not dependent on an employer as is the SEP and SIMPE IRA.
A Traditional IRA can be established by individual taxpayers, who are allowed to contribute 100% of compensation (self-employment income for sole proprietors and partners) up to a set maximum dollar amount. A Traditional IRA is held at a custodian institution such as a bank or brokerage, and may be invested in anything that the custodian allows. The main advantage of a Traditional IRA, compared to a Roth IRA, is that contributions are often tax-deductible. If a taxpayer contributes $4,000 to a traditional IRA and is in the twenty-five percent marginal tax bracket, then a $1,000 benefit ($1,000 reduced tax liability) will be realized for the year.
A Roth IRA can be established by individual taxpayers, and can invest in securities such as stock and mutual funds. In contrast to a traditional IRA, contributions to a Roth IRA are not tax-deductible. Withdrawals are tax-free. An advantage of the Roth IRA over a traditional IRA is that there are fewer withdrawal restrictions and requirements. Transactions inside the Roth IRA account (including capital gains, dividends, and interest) do not incur a current tax liability. Withdrawals are generally tax free when the account has been opened for at least 5 years and the owner’s age is at least 59 ½.
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