What Are the Tax Benefits of Opening an IRA?
An Individual Retirement Arrangement (IRA, also known as Individual Retirement Account) is a type of personal retirement investment. Unlike 401(k) plans in which many people participate through their employers, IRAs are for people who would like to privately invest and save for retirement. One of the most important benefits of IRAs is the many tax advantages which they grant their investors.
Other People Are Reading
-
Types of IRA Accounts
-
Investors may open many different types of IRA accounts, but the two most common are Traditional IRAs and Roth IRAs. The two types are quite similar in many respects. For example, you may contribute to either kind of IRA while simultaneously taking part in your job's 401(k) program or similar retirement program. Anyone under the age of 70 1/2 may contribute to an IRA, and the two types of accounts have similar contribution limits. The differences between the two accounts largely lay in their tax liability and withdrawal penalty policies.
Tax-Deferred Income
-
Both types of IRAs defer the tax liability on your savings as your investment grows. Once you withdraw your investment from your IRA, the IRS counts the income you receive from your account as taxable income. However, while your money sits and grows in your IRS, you don't owe any taxes on any interest growth in the account. Because you can fund some types of IRAs with pre-tax dollars from your paycheck, you can put off paying taxes on that income for many years.
-
Pre-tax Contributions
-
Traditional IRAs allow you to fund the account with pre-tax dollars you earn from your job. This means that the money comes out of your paycheck before the government takes out your income taxes and Medicare and Social Security deductions. Because that money would have been taxed had it remained in your paycheck, you may not see as large a deduction in your take-home pay as what you are actually investing. You may also be able to roll over any of your pre-tax 401(k) contributions into your IRA, so you won't pay taxes on that income, either.
Tax-Free Withdrawals
-
In contrast to Traditional IRAs, you must fund Roth IRAs with after-tax dollars. You've already paid taxes on this income, so your withdrawals from this account will be tax-free, because the IRS can't tax the income twice. This makes Roth IRAs a tax-sound investment not only for your own retirement purposes, but may also offer you additional peace of mind when leaving your investments to your will beneficiaries. They won't have to pay taxes when cashing in your IRA investments, either.
Deducting Contributions
-
Depending on your income eligibility, you may be able to deduct your contributions to a Traditional IRA on your tax returns, either fully or in part. As of 2010, if your adjusted gross household income is less than $56,000 as a single taxpayer, or less than $89,000 if married filing jointly, you may deduct your IRA contribution in full from your tax return. If your income as a single or head of household tax filer is between $56,000 and $66,000, or between $89,000 and $109,000 if married filing jointly, you will be able to count at least part of your IRA contribution for the year as a deduction on your tax return.
-
