Selecting the correct investment plan is important and can be different for everyone. While there’s no one cookie cutter answer for all, each plan is standard in the way it operates. 401K’s to IRA’s, you will likely the find bases necessary for you to begin saving. One of the most common plans is an IRA. However, there are two versions of an IRA and it’s important to understand the differences between them.
What is an IRA?
First, let us go over what an IRA is. An Individual Retirement Account is an investment account that allows you to make contributions in an effort to save for retirement. These accounts can be created by anyone and there are not restricted to employers, like the 401K is.
There are contribution limits set each year, capping the amount of money you can contribute. Within the IRA, you can make investments into nearly anything you want. Keep in mind that once you’ve contributed money, depending on your plan it’s stuck there until retirement. Early distributions from a traditional IRA will cost you 20% in taxes and an additional 10% penalty.
Differences between the two plans
Now, it’s important to understand the main differences between an IRA and Roth IRA. Knowing them will allow you to make a more informed decision when opening your account.
A traditional IRA is straightforward in that you can make pre-tax contributions into your account. From there, you can invest the money and allow it to appreciate pre-tax. However, when it comes time for distributions, you will be taxed at your current level.
Within this plan, you are unable to take distributions prior to retirement without penalty. Once money is in the plan consider it locked in.
A Roth IRA operates a bit differently in that it uses post-tax dollars. Like a traditional IRA, you can invest your money how you see fit. An added benefit to a Roth IRA is you can withdraw your principal balance without penalty because it’s post-tax dollars.
This particular plan benefits those looking to pass down their wealthy or plan on building more wealth than the average individual. However, if you want to withdraw your earnings, you’ll be penalized on those funds.
Some of the similarities real fast include the same contribution limits, same investment options and account opening ability.
Selecting the right IRA plan comes down to your individual needs and goals. If you are looking to build generational wealth, then a Roth IRA may be the best for you. Looking to simply take care of you and your spouse? Then a traditional IRA may suffice. Always consult your financial professional before making decisions. Once committed, it can be difficult to alter your selections.