What is an IRA.
You may have heard this term thrown around before and never looked into it, but its probably one of the most important financial accounts you should know about. IRA, stands for Individual Retirement Account. There are two different types, Traditional IRA and Roth IRA. We’ll get into the details of these later on but all you need to know is that it is a brokerage account with certain tax benefits. Think of the account as just a vehicle to drive your money until you can withdraw it in retirement. What direction you drive I.E. what stocks, bonds, mutual funds and index funds you decide to buy are entirely up t o you. If you wanted to, you can simply open a regular brokerage account (TD Ameritrade, Fidelity, E-trade etc…) and do the same exact thing except you wont benefit from the tax savings that a retirement account would give.
Now that you know what an IRA is lets get into some of the details of each type.
Traditional IRA. A traditional IRA gives immediate tax benefits right now this tax year. Any money you put in is considered pre-tax income. So for example if you made $50,000 last year and you contributed $5,000 into a traditional IRA your personal income would look like you made $45,000 get it? What about down the line 30 years from now in retirement? That’s where things get tricky. Lets say you retired with $500,000 in the IRA (because of the wonder of compound interest yayyy!). You want to celebrate and take $30,000 out and go on a world cruise and lets say your still making $50,000 that year. What happens is that $30,000 gets added to your personal income and it looks like you made $80,000. Which means you get taxed on $80,000 and by the time we retire as Millennials who knows what the tax brackets will be or how much the national debt will have skyrocketed to. See the problem with delaying taxes for us?
Roth IRA. A Roth IRA does not have the same tax benefits in the year in which the contribution was made. So if we take the same example of a $5,000 contribution into a Roth IRA and you are making a salary of $50,000, your personal income for that year would still be $50,000. The benefit of a Roth IRA is at the back end after you retire. Lets take the same scenario as before. You retired and want to take out $30,000 and go on a world cruise and lets say you’re still making $50,000 that year. Your yearly income would still be $50,000 even though you received $30,000 from your Roth IRA that year. The important benefit of this is that ANY money withdrawn is not taxed. Let me say that again ANY money withdrawn in retirement is not taxed. This includes all the profits from stock appreciation and all of that compound interest that has been accumulating in the account for 30+ years. You could have a Roth IRA worth $1 Million and ALL of it is yours to use. That is better then winning the lotto!
Now that we know the different types of IRA’s, its time to get one! It doesn’t matter how close or how far from retirement you are. The earlier you start the better off you will be. Take advantage of the tax breaks and your future self will thank you!
