I, of course, have an opinion on this subject, but first I will lay out the differences to them and how they pertain to mutual funds.
A Roth IRA (heretofore referred to as RIRA) and a Tradtional IRA (heretofore referred to as TIRA) are retirement vehicles. By that I mean, they are designed to help you have a retirement income, the market willing. So you put money into these investments and they grow to a nest egg. I say, market willing, because there is NO GUARANTEE that the investment you put your money into will grow at all and it could even lose money. That is the sad truth about the stock market. But overall the actual long term rate of return is better than a savings bond. Here is a website you can put dates into and adjust for inflation to find out rate of return over a specific period of time. Remember, though, someone trying to sell you something will show you rates of return that are positive, more times than not. Play around with the dates. Say, what if I started investing January 1, 2000, what return would I have realized by December 31, 2011? I used this site Compound Annual Growth Rate. My average return was only -.13% and annualized return was actually -1.93%. Ouch!
Now change the dates to January 1, 1990 to December 31, 2011. The average return is 7.12% and annualized return is 5.14%. When I change the dates to January 1, 1980 to December 31, 2011 the average return is over 8% and annualized return is over 7%. What does this mean to you? Well, what I would think just looking at the raw data is that the longer I stay invested the better my return. Do you see the same thing? When I look at the yearly breakdowns on the site I see that there are some really good years and some really bad years. The market is cyclical. It goes up and down. Just be prepared to stick it out through thick and thin if this is route you intend to take.
Okay, enough about returns. Let's talk more about the differences between the TIRA and the RIRA (did you remember what they meant? You didn't know there would be a pop quiz did you? lol). In a nutshell the TIRA is what is called TAX DEFERRED. In other words, you can right off the amount you invest yearly (most of the time...we will discuss further in a minute) from your taxes, but the amount you finally withdraw after 59 1/2 is taxed at your new tax rate. Everything you put in and all the earnings are taxed. The RIRA, on the other hand, is TAX FREE. You can't deduct any amount from your taxes. But all the money that you put in and all the money your money earned is not taxed when you finally withdraw it at after age 59 1/2.
As you notice, I referred to an age....59 1/2. That is the age that was designated as the beginning of "retirement." Another age that is important is 70 1/2. With a TIRA you are required to start withdrawing funds whether you need them or not. Not so with the RIRA. You never have to withdraw funds from your RIRA. Here's the thing, though, once you start withdrawing you have to continue. And there are rules governing the withdrawal...yep rules and rules. This isn't a spigot you can stop.
Also, if you decide you are in dire financial straits and need the money from your TIRA, you can withdraw money, but you will be fined a 10% penalty, plus you will pay taxes on the money withdrawn. This is usually a big enough deterrent to stop people from using their IRAs as a savings account. There are exceptions to the penalty and the rules are found here: IRS From this link you can follow links to other publications. Now with a RIRA the rules are a little different. You may withdraw the amount you put into the RIRA per this: It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and the payment or distribution is: made on or after the date you reach age 59½, made because you are disabled, made to a beneficiary or to your estate after your death, or one that meets the requirements listed under First home under Exceptions in chapter 1 of Publication 590 (up to a $10,000 lifetime limit).
Okay, enough about returns. Let's talk more about the differences between the TIRA and the RIRA (did you remember what they meant? You didn't know there would be a pop quiz did you? lol). In a nutshell the TIRA is what is called TAX DEFERRED. In other words, you can right off the amount you invest yearly (most of the time...we will discuss further in a minute) from your taxes, but the amount you finally withdraw after 59 1/2 is taxed at your new tax rate. Everything you put in and all the earnings are taxed. The RIRA, on the other hand, is TAX FREE. You can't deduct any amount from your taxes. But all the money that you put in and all the money your money earned is not taxed when you finally withdraw it at after age 59 1/2.
As you notice, I referred to an age....59 1/2. That is the age that was designated as the beginning of "retirement." Another age that is important is 70 1/2. With a TIRA you are required to start withdrawing funds whether you need them or not. Not so with the RIRA. You never have to withdraw funds from your RIRA. Here's the thing, though, once you start withdrawing you have to continue. And there are rules governing the withdrawal...yep rules and rules. This isn't a spigot you can stop.
Also, if you decide you are in dire financial straits and need the money from your TIRA, you can withdraw money, but you will be fined a 10% penalty, plus you will pay taxes on the money withdrawn. This is usually a big enough deterrent to stop people from using their IRAs as a savings account. There are exceptions to the penalty and the rules are found here: IRS From this link you can follow links to other publications. Now with a RIRA the rules are a little different. You may withdraw the amount you put into the RIRA per this: It is made after the 5-year period beginning with the first taxable year for which a contribution was made to a Roth IRA set up for your benefit, and the payment or distribution is: made on or after the date you reach age 59½, made because you are disabled, made to a beneficiary or to your estate after your death, or one that meets the requirements listed under First home under Exceptions in chapter 1 of Publication 590 (up to a $10,000 lifetime limit).
I hope I haven't confused you too much at this point. Now an IRA, either one, can be opened using either a mutual fund, a savings account, or you can individually trade stocks through a brokerage account. I would NOT suggest this last option unless you are schooled in the nuances of trading. So when you tell me that you have an IRA and a mutual fund I will ask what your IRA is invested in and then gently remind you that your IRA is in a mutual fund (more times than not). A "mutual fund" that is separate is from your IRA is a taxable investment vehicle that is not intended for retirement usually.
Oh yeah, before I forget, your Individual Retirement Account has contribution limits. It is $5,000 per year, unless you are over 50 and that limit is $6,000 per year. And that is all based on your Adjusted Gross Income (AGI on your 1040). Refer to the link above to get specifics or email me and I will help you if you have concerns.
Here's the kicker, my girlfriends, you can contribute the maximum amount to your IRA whether or not you have earned income in your name. And let me suggest you do so. Now. Do this before the kids' education. (find my post on that in the archive section)
The title Individual Retirement Account means just that...it is for the individual who's name is on the account. Just because your spouse, Jim Bob, has an account does not mean you have an IRA. You may be the beneficiary, but when push comes to shove that account is Jim Bob's. Get your own. Demand your own. You are entitled.
I told you at the beginning that I have an opinion as to which type of IRA I prefer...it is the RIRA. I like the idea of tax-free later in life. My life has been busy and complicated enough so far. I want simple during my sunset years. That's my 2 cents :)
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