Roth Vs. Tradional Vs. Rollover IRA
There are two basic types of IRAs: traditional and Roth. When saving money for your retirement, either type of IRA may be suitable for you. Once the money is in your IRA, you may invest it into mutual funds, stocks, annuities, real estate or precious metals. However, you may also want to roll your money over from one type of IRA to another type. Make sure you understand the mechanics of all of the various types of IRAs and how a rollover IRA may factor into your retirement plan.
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Types
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A traditional IRA accepts pretax contributions into the IRA account. Money is then invested into various investments and tax is deferred on investment income. When you withdraw money from the account, you are taxed at ordinary income tax rates. Roth IRAs accept only after-tax contributions. They offer the same investment options as traditional IRAs and tax-deferred investment income, but the money withdrawn from the IRA is tax-free.
Significance
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The significance of a traditional IRA is that income taxes are deferred until a later time. By not paying taxes as you earn income, you are able to invest more of your income and thus may end up with a larger savings at retirement. The significance of a Roth IRA is that distributions from the account are tax-free. This allows you to have more net income during your retirement than you may have with a traditional IRA, but your total IRA savings may be smaller due to the fact that taxes were taken out of your contributions when you made them.
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Rollover
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A rollover IRA refers to a process where you transfer your savings from one IRA to another. This requires that you contact your existing brokerage for a transfer request form. You must fill out this form and include your personal information such as your name, address and Social Security Number. You must also include the account number of your existing IRA and the new IRA you want to roll the money into. Finally, you must sign and date the form and turn it in to your existing brokerage firm and wait for the money to be transferred.
Warning
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When transferring money from a traditional IRA to a Roth IRA, you will pay taxes on all of the money in the IRA. This is because the Roth IRA only accepts after tax contributions where the traditional IRA accepts pretax contributions. This could result in a large tax liability when you transfer from the traditional IRA to the Roth IRA.
Considerations
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When considering which type of IRA to invest in, or whether you want to roll your money over from one IRA to another, make sure you analyze the full impact of your decision. Traditional IRAs are ideal if you believe that future tax rates will fall, or you will be in a low tax bracket when you retire. A Roth IRA is ideal for when you believe tax rates will be higher in the future, or you think you will be in a higher tax bracket when you retire. Rolling your money over from a traditional IRA to a Roth IRA should only be considered when you have enough time to make up the losses you suffer in taxes during the transfer.
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