If you visit a retirement planner for help, they might suggest using an IRA as one tool for retirement planning. IRAs are common for retirement plans, and they offer many benefits. If you are interested in investing for retirement, an IRA is a great option. Here is an explanation of the two types of IRAs you can choose from and how they work.
Traditional IRAs
IRA stands for "individual retirement account," and the first type you can choose is a traditional IRA. A traditional IRA tends to work well for most people, and it offers benefits right now. When you use a traditional IRA, you can write off the contributions you make when you file your taxes. When you do this, it reduces your taxable income during this year, leaving you with a lower tax liability to the IRS.
You can only invest a limited amount of money each year into a traditional IRA, and the amount changes yearly. As of 2020, you can place $6,000 a year in an IRA. If you are 50 years old or older, you can put in $7,000. You cannot contribute more than this amount. If you do, you can only write off the maximum allowable amount on your taxes.
When you retire, you can begin taking withdrawals from your IRA. The downside is that you must pay taxes on the withdrawals at this time. You pay taxes on the money then because you did not pay taxes on it when you invested it.
A traditional IRA is ideal for people who plan on earning less money when they retire than the amount they currently earn.
Roth IRAs
A Roth IRA works like a traditional IRA in certain ways, but it is also different. The main difference is that your contributions are not tax-free right now. You cannot write-off your contributions on your taxes during the years you invest money. Instead, you pay taxes on the money now. The benefit of this is that you will not pay any taxes on your withdrawals when you retire because you already paid taxes on this money.
If you feel that you will earn more money during retirement than you do now, it might be better to use a Roth IRA than a traditional one.
If you need advice about investing for retirement, talk to a retirement planner. A planner can give you options and tips to help you make the right choices.