An IRA is an Individual Retirement Account. It is an investment fund designed to provide you with income during your retirement years. Many people are familiar with an IRA since 401Ks are offered through some employers. Most people rarely know the difference between the types of IRAs and their pros and cons.
When I sit down with a client, my main objective is to create a financial game plan for them, which includes helping them invest so that they do no retire broke. Many of my clients have sums of money in dead 401Ks or IRAs from previous employers that are earning close to nothing in interest. A part of my duty is to make sure they understand what they have, how it works and how I can help them with the possibility of better performance.
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There are two types of IRA’s – a ROTH and a traditional IRA. The ROTH IRA was originally sponsored by William V. Roth Jr., a United States Senator. He was a strong advocate of tax cuts and co-authored along with John Kemp the “Economic Recovery Tax Act of 1981″, also know as the Kemp-Roth tax cut. Senator Roth was also the legislative sponsor for the individual retirement account that bears his name, ROTH IRA - 1998.
The main difference between the traditional IRA and the ROTH IRA are taxes. Money that grows in a traditional IRA is pre-taxed, meaning the moneys has yet to be taxed. When the person who retires begins to take a distribution, they will be taxed on the full amount in the account. With a ROTH IRA, the money grows tax free, provided the liquid assets are used for qualifying events: (i.e., retirement, the first time purchase of a home – up to $10,000, death or disability).
With both the traditional IRA and the ROTH IRA, distributions should begin no sooner than 59 1/2 years old. If a client decides to withdraw their funds before that time, they will be assessed a 10% penalty if the withdrawal is not one of the aforementioned, “qualifying events”. Also, with an IRA, you must begin to take a distribution before 70 1/2 years old or you will be penalized 6%. There are no such limitations for the ROTH IRA.
With both the traditional IRA and the ROTH IRA, you can make an annual contribution of $5,000 or $6000 for those 50 and over.
Who should invest in a ROTH IRA? I believe that everyone should consider the ROTH IRA as a viable investment option. I particularly like the idea of my money growing tax- free. I really enjoy sharing with my clients the pros and cons of both and allowing them to come to their own conclusions, which is usually the ROTH. There’s something about the thought of ones money growing without the burden of taxes that feels really sexy in the investment process.
At the end of the day, the moral of the story is, start investing. Yes, the ROTH IRA is a great investment tool but if you are one to get caught up in the semantics of this and that, focus on the big picture…making sure that your family doesn’t retire broke.
Until next time,
Regional Vice President, Primerica