There are many different types of retirement plans and accounts. They are generally not investments themselves, but rather hold investments earmarked for retirement, such as mutual funds or individual securities.
Individual Retirement Accounts, or IRAs, are some of the most popular tax advantaged retirement vehicles available to investors today. IRAs may be opened up at many different financial institutions. Personally I prefer to open IRAs at discount brokerage firms since they tend to charge the lowest fees. Some of the most popular IRA providers include:
The two most popular types of IRAs are Traditional IRAs and Roth IRAs. Here is a very brief summary of each.
- Contributions may be fully or partially deductible (made pre-tax) under certain conditions.
- Earnings and appreciation grow tax deferred until distributed.
- Most or all withdrawals will likely be taxable as ordinary income when distributed.
- To contribute you must generally be under age 70.5 and have earned income.
- Contributions may generally be made for a year until April 15 of the following year.
- Withdrawals made before age 59.5 will likely be taxable and may be subject to an additional 10% federal tax penalty (although there are exceptions).
- Withdrawals may be made penalty free after reaching age 59.5 and distributions may be used for any purpose.
- Account owners may begin taking distributions at age 59.5 penalty free but must begin receiving minimum distributions by April 1 of the year following the year they turn age 70.5.
- There are additional limitations as to who may contribute to a Traditional IRA and how much can be contributed each year.
- There is no up-front tax deduction, so contributions are made after tax.
- Funds in a Roth IRA grow tax deferred and may eventually be withdrawn completely free of tax (both contributions as well as income/appreciation) if certain requirements are met. This means that future earnings and appreciation may accumulate and grow over time and then be withdrawn free of tax. That is quite a deal!
- Contributions can be made to a Roth IRA at any age.
- Roth IRA contributions may generally be made for a year until April 15 of the following year.
- Principal contributed (but not earnings) may be withdrawn tax and penalty free at any time. However, once withdrawn, those funds have lost the opportunity to continue to grow tax free.
- Earnings may be withdrawn tax free if the Roth has been in place for at least 5 years and you are at least age 59.5 at the time of withdrawal. There are a few other exceptions as well.
- There are no required minimum distributions until the account owner dies, so account assets can continue to grow tax free longer.
- There are additional limitations as to who may contribute to a Roth IRA
- A Roth IRA is a fantastic estate planning tool.
If appropriate for you, open an IRA and begin investing as soon as possible so that your money can grow tax deferred or exempt as long as possible.
If you have maxed out your IRA contributions, or if you are ineligible to contribute to an IRA, you might consider investing any additional funds in a brokerage account.