After deciding to invest in an IRA (Individual Retirement Account) you further have to make the distinction as to whether you want to invest in a Roth IRA or a Traditional IRA. These two investment vehicles have very different tax implications so considering your specific circumstances is important. Traditional IRAs: These offer the benefit of allowing you to deduct the contributions you make now from your taxable income and reduce your tax bill. You pay taxes later in your retirement when you are withdrawing amounts, so effectively you defer taxes and potentially pay lower taxes if you expect not to have as much income in the future.
Traditional IRAs also limit you from withdrawing the account before you turn 60; if you do you pay large penalties. Roth IRAs: Roth IRAs don’t allow you a tax deduction now, but your earnings and withdrawals are tax-free when you take them out later. This can be advantageous if you expect to have a higher tax rate in retirement, so you pay lower overall taxes by paying now. Roth IRAs also allow you to withdraw contributions, but not earnings, whenever you want without penalty. An added benefit of Roth IRAs is that you aren’t required to begin withdrawing from them when you turn 70, as you are with a traditional IRA. This can be useful if you’d rather leave the funds alone and not be forced to withdraw them. Additionally, as the beneficiaries of Roth IRAs don’t pay taxes when they receive the funds these can be a useful wealth transfer vehicle. Ultimately choosing the right IRA for you requires you to consider your current and future tax expectations, as well as when you think you may need the funds.