Individual retirement accounts allow individuals without access to 401(k) or pension plans to maximize retirement savings. These plans can also be used to supplement an employer-provided savings plan. While anyone can open a traditional IRA, at publication date individuals with an adjusted gross income of less than $120,000 and married couples with an AGI of less than $176,000 may open a Roth IRA; these numbers increase for tax year 2013. Though these two accounts are often distinguished based on how they are taxed, traditional IRA and Roth IRA accounts actually differ in a number of other ways.
When you contribute to a traditional IRA account, you are saving pretax dollars. That means you don't pay taxes on this money now, but must pay taxes when you withdraw the money. Contributions to a Roth IRA are made with after-tax dollars, so you must pay taxes on the money now, but can withdraw it after retirement without paying taxes.
The Internal Revenue Service sets the same annual contribution limit for traditional and Roth IRAs. For tax year 2012, account holders under the age of 50 may contribute a maximum of $5,000 per year, while those 50 and older can contribute up to $6,000 per year. The contributions for tax year 2013 are $5,500 and $6,500, respectively. When you reach the age of 70 1/2, you may no longer contribute to your traditional IRA. With a Roth IRA, you can continue to make contributions to your account for as long as you wish.
Contributions made to a Roth IRA cannot be deducted on your income tax return. If you do not have access to a retirement plan at work and you are a single taxpayer with an AGI under $68,000 per year or a married taxpayer with an AGI under $112,000 per year, you may deduct contributions made to a traditional IRA. This deduction is phased out for those with an AGI exceeding these amounts, and these amounts are increased for tax year 2013 to $69,000 and $115,000, respectively.
Account holders may begin taking penalty-free withdraws from either a traditional IRA or Roth IRA beginning at age 59 1/2. While Roth IRA account holders are not required to take withdrawals at any time, traditional IRA account holders must begin to take minimum required withdrawals beginning at age 70 1/2. These accounts also differ in how early withdrawals are treated. Account holders may withdraw contributions made to a Roth IRA at anytime without penalty. Early withdrawals from a traditional IRA come with a stiff IRS penalty unless the withdrawal is made for reasons permitted by the IRS, including purchasing a first home or paying for educational expenses.
- Jupiterimages/liquidlibrary/Getty Images