Roth versus Traditional IRA

If you are like most people, you probably know the importance of saving for your retirement.

An IRA, or Individual Retirement Account, is one way you can start investing money for your retirement. This type of account allows you to contribute part of your income to it each year. While there is a limit to the amount you can contribute each year, if you are over 50, this amount increases.

There are two main types of IRAs-Roth and traditional. These accounts are similar in many ways, the main differences being how the money is taxed.

The following is an overview of traditional vs. Roth IRAs and how to determine which is right for you.

Traditional IRA
With a traditional IRA, the money is tax-deferred. This means you don't have to pay taxes on earnings, interest, dividends, or any gains until you start withdrawing the money. The exception to this is a 10% penalty that goes into effect if you take money from the account before you are 59 ½. This penalty has exemptions, however. In addition, you must start withdrawing money from your IRA by the time you are 70 ½.

You can use traditional IRA funds to purchase a wide range of investments, such as stocks or bonds. With a traditional IRA, there is no income restriction-this type of account is available to anyone.

Roth IRA
With a Roth IRA, your contributions are not tax deductible, but all of your earnings and principals remain tax free as long as you follow the specific regulations. In addition, there is no mandatory age where you must begin withdrawing money.

A Roth IRA differs in that it is only available to those who file their taxes singly and make $95,000 a year or less, or to married couples who make no more than $150,000 each year. Like the traditional IRA, it can be used for a wide range of investments. There is also an early withdrawal penalty of 10%, but there are exceptions.

Which to choose
If you are not sure whether you should invest in a traditional IRA or a Roth, keep in mind that there are eligibility requirements that must be met. With a Roth, you can withdraw 100% of your money tax-free, and with a traditional IRA, you can deduct your contribution on your taxes. For example, if you make $75,000 a year and put $5,000 in a traditional IRA, you only pay $70,000 in taxes.

At the same time, with a Roth IRA, you won't receive that income tax deduction, but you can still take the principal of the money in your Roth at any time, rather than when you are 59 ½, as with a traditional IRA. For the average middle class family, a Roth IRA will make the most sense financially.

Regardless of the type of IRA account you want to open, you can open them at a bank or with a broker. Experts recommend that if you plan on holding investments like stocks and bonds in your IRA, you go through a broker, who is more experienced in handling that type of situation.

Before opening an IRA, it is important to do your own research to find out which type is right for you and your financial goals. Eligibility requirements and penalties differ, so make sure you know exactly what is required before opening an IRA.