Individual Retirement Account

Which Individual Retirement Account Is Best For You?

It’s best to allow your money to grow tax free. Sure it can be a pain to get at it, but those premature withdrawal penalties might actually be good for us, since they’re an effective deterrent to sticking our hands in the cookie jar.

If you’re 22 and put the current maximum of $4000 a year in a tax sheltered plan that grows at 10% a year, the long term average return of the US stock markets, when you’re 65 you’ll have about $2,600,000.

But, if you invest using a regular, taxable, brokerage or mutual fund account, you’ll only amass $940,000, assuming a 6.6% after tax return. Using tax shelters gives you a cool extra $1.6 million.

Our good old Uncle Sam has been accommodating lately, adding more ways to get rich slowly in a tax free way.

We now have four common ways to save and invest without taxation. 401 K Plans: Health Savings Accounts: 529 Educational Savings Plans: and IRA's.

Depending on your goal, college tuition, heath care or retirement, use them to your best advantage.

This article will compare the two forms of Individual Retirement Accounts, the Traditional or Regular IRA and the Roth IRA.

Traditional Individual Retirement Accounts

Traditional Individual Retirement Accounts allow you to contribute up to maximum of $4000 a year, $5000 if your 50 or over (rising to $5000 and $5500 respectively in 2006) and deduct the contribution from your taxes. There are severe restrictions that limit the availability of deductible IRA’s.

Traditional Individual Retirement Accounts also exist in a non-deductible form. They are allowable for individuals whose circumstances prevent contributions to deductible IRA’s whose income didn’t exceed certain limitations.

Like the Traditional IRA, there are income limits that start to cut into and eventually prohibit Roth Individual Retirement Account contributions.

Here are the current IRS rules as far as IRA contributions go:

Single, Head of Household or Qualifying Widow(er):

• Below $95,000: full contribution
• $95,000-$109,999: prorated contribution
• $110,000 or over: no contribution permissible

Married Filing Jointly:

• Below $150,000: full contribution
• $150,000-159,999: prorated contribution
• $160,000 or over: no contribution permissible

Married Filing Separately:

• $0-$9,999: prorated contribution
• $10,000 or over: No contribution permissible
[Yes you read that right.]

The contribution limits to Roth and Traditional Individual Retirement Accounts are the same. The big difference between the two is what happens when you make withdrawals.

Roth IRA’s

With both Traditional and Roth IRA’s, money cannot be withdrawn without penalty, except in certain circumstances. With a Roth Individual Retirement Account the account must have been opened for at least five years or you will pay taxes and penalties, even if you take out the money for otherwise allowable purposes.

You can make penalty free withdrawals from Individual Retirement Accounts for the following reasons;

• Qualified educational costs
• First time home purchase, up to $10,000
• Payment of excessive unreimbursed medical expenses
• Payment of medical insurance premiums while unemployed
• Total and permanent disability
• Distribution of account assets to a beneficiary after you die

You also can get early access without penalty if you take IRA money on a specific schedule, known as substantially equal periodic payments. This allows you to begin withdrawing from your IRA early, as determined by an IRS life-expectancy table. Withdrawals must continue until you are at least 59 ½.

But you really shouldn’t take your money out if you can help it. Let it grow tax free until you retire. Remember there is no financial aide for retirement.

You can start to withdraw money from both plans, subject to the five year rule for Roth’s, at age 59 ½ without penalty.

There are several major differences between Traditional and Roth Individual Retirement Accounts.

You must start withdrawing money from Traditional Individual Retirement Accounts at age 70 ½ and the IRS sets regulations as to minimum withdrawals you must make. The money you withdraw from a Traditional IRA is fully taxable.

Roth IRA’s on the other hand are treated differently. Premature withdrawals of your contributions (as opposed to the money earned) are not taxable. Once you reach 59 1/2, all withdrawals are totally free from tax. Since they are not included in gross Finance Square income, they will not increase your tax bracket, effect your Social Security check or get you entangled in the web of the Alternative Minimum Tax.

Also you are not required to make withdrawals at any age. A Roth Individual Retirement Account can be used to build an estate for your heirs.

[Remember what the government gives it can take away. There is no certainty that these rules will not be changed. The government has done it before and undoubtedly will do it again.]

You can convert a Traditional Individual Retirement Account to a Roth IRA, which might be worth it if you’re still young. This can be done only if your adjusted gross income is under $100,000. The money from the Traditional IRA is taxed at your regular rate and you can’t use any of the IRA money to pay the taxes. The younger you are, the more sense this makes. Click here for a calculator to help you determine if conversion makes sense for you.

You can invest in lots of different things and if you know what you’re doing it might make sense to do so. For those of us inexperienced in stock trading, gold bullion, options,etc, its best to stick with no load mutual funds. Forbes Magazine and Consumer Reports periodically run articles about top rated funds, those with low fees and good long term track records.

If you are lost and don’t know what to do, I suggest you go to Vanguard to open your IRA account. Then invest in one of their excellent very low cost index funds.

Fill up your 401 K Plan first. If you don’t have a 401 K or you have more to invest, move on to a Roth Individual Retirement Account, a Health Savings Plan or a 529 Educational Savings Plan, depending on your goals. You’ll be glad you did.

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