IRA Safety
IRAs are investment accounts that shelter your retirement savings from income taxes. IRAs are generally considered to be safe, though it somewhat depends on the investments you purchase in the IRA. Because IRAs can buy many different types of investments, you must understand how these investment accounts work before investing in one.
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Types
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There are two types of IRA. A traditional IRA is an IRA that accepts pretax contributions to the account, defers income tax during your lifetime and taxes all withdrawals. A Roth IRA allows after-tax contributions and does not tax any withdrawals after age 59 1/2.
Function
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The function of a traditional IRA is to provide the most amount of investment contributions to the account through pretax contributions. The function of the Roth IRA is to provide the maximum amount of retirement income by not taxing distributions. Both types of IRAs share a common function: to provide special tax advantages to allow your retirement savings to grow over your lifetime as opposed to taxing the earnings on your investments every year.
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Benefits
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The benefit of a traditional IRA is that you may accumulate a large total retirement savings due to the pretax contributions and the tax deferral on earnings in the account. The benefit of a Roth is that you don't have to worry about future tax rates during your retirement.
Disadvantages
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The disadvantage to a traditional IRA is that you must withdraw money from the account by age 70 1/2. If you do not, you are assessed a penalty of 50 percent on the amount of money you should have withdrawn but did not. The disadvantage to a Roth IRA is that all of your contributions are after tax contributions. This means that it takes more money to fund a Roth IRA, since part of the contribution that would have gone to the Roth goes to paying taxes on the contribution. The disadvantage to both types of IRAs is that there are contribution limits to the account. You may only contribute a maximum of $5,000 per year if you are under 50 years old. If you are 50 or older, you may contribute up to $6,000 per year.
Considerations
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When you are trying to decide on whether or not to invest in an IRA, consider whether you could do better outside of an IRA. In most cases, the tax benefits of an IRA account are more attractive than other investment alternatives. However, an annuity is an insurance product that offers some of the advantages of an IRA, but does not have any contribution limits. Annuities are funded with after-tax contributions, however, and all investment earnings are taxed when you make withdrawals from the account.
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