As a very financially illiterate person, I’m just now entering the adult world and trying to start being smart with my money. Any tips/advice on how to navigate opening an IRA would be lovely!
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I has to do with when you pay taxes.
A regular IRA, your money comes out of your pay, and goes into you retirement savings BEFORE taxes. You are not taxed on this money. Later, when you are retired and you start getting payments from your retirement savings, you pay taxes on the payout.
A ROTH IRA, you **DO** pay taxes on the money, BEFORE you put them money in. But you DON’T pay taxes on the payout when get your retirement money out.
So you do you want pay taxes NOW or Later?
Some people like the idea of not being taxes now, because they think that leaves them more money now, which for example, means more actual money they can put in the account. (the more you put in sooner, the bigger it can grow)
Some people like the idea of paying taxes later, because they assume their tax rate when they are old and retired will be lower than their tax rate when they are young and working.
A Roth IRA is a type of retirement investing account in the US. It isn’t an investment itself, it’s a type of account that you can have investments in.
A Roth account has tax benefits if you use the money for retirement. You’ll use after tax money and put in an interest earning investment. Once you retire, you won’t have to pay taxes on all the growth. But if you pull it out early, you’ll owe taxes and will have to pay a penalty in most circumstances (the point of this is retirement). You can also only contribute $6000 a year to it.
IRA stands for individual retirement account, meaning that it isn’t offered through an employer (like a 401k). You’ll need to go to an investment company to open one. There’s a bunch of companies that do this, but some are vanguard (where mine is), fidelity, and Charles Schwab.
Check out resources like r/personalfinance , Nerd Wallet and Investopedia to do more research on this.
An IRA is an Individual Retirement Account. It is *Individual* because you as a private citizen open one for yourself. This is in contrast to another retirement account known as a 401(k) that is provided by private employers. Similar set-up, except the employer can contribute money to the 401(k) account, too – all the money in an IRA comes from your own pay check.
IRAs offer special tax protections on your money.
jrhooo and lethal_rads already did a good job explaining the main differences. A key thing I would add is that the “retirement age” is 59.5 years of age for most people. If you try to make regular withdrawals from the account before then, you will get hit with some hefty penalty fees. There are some circumstances where you can take out a loan against your IRA account, which is something people sometimes do when they are buying a home and need money for a down payment, though this has its disadvantages since you’re basically taking money out of your retirement fund. Maybe some people can afford that, but that’s a personal decision you’d have to make for yourself at that point.
A Roth IRA is a type of IRA.
So first, an IRA is an Individual Retirement Arrangement ([not account](https://www.irs.gov/retirement-plans/individual-retirement-arrangements-iras)). It’s a way to save money for retirement. It’s called an Individual arrangement because you set it up; it’s not done through your employer.
When you contribute to an IRA, unless you make over a certain amount, you can deduct the amount you contribute from your taxes. When you take the money out at retirement, you pay taxes on the money you take out.
Now back to Roths. Roth IRAs are the same as traditional IRAs, except you don’t get a tax deduction on the money you contribute. You pay taxes now, but you aren’t taxed when you take the money out at retirement.
Another important difference is required minimum distributions (RMDs). With a traditional IRA, you must start withdrawing money from it when you reach a certain age. The reason is there’s a huge lump sum on which you owe taxes, and the IRS would like those taxes. Roth IRAs have no RMDs while you’re alive. Your heirs may need to take RMDs, but you do not.
You can open an IRA at any of the major brokerage firms (Fidelity, Vanguard, T. Rowe Price, etc). Don’t open IRAs at your bank.
Also there’s a TON of info and resources out there to learn as much as you want to about this topic, but my IRA isn’t something I wanted to be super hands on with as far as managing it, trading shares, etc. You can’t just dump your money in the account and expect it to work for you, you have to purchase shares of funds/companies with the money you put in there. (May seem obvious but just wanted it to be stated clearly!)
There are mutual funds that are geared towards retiring by a certain year that will be managed more aggressively at first and taper off to more risk-adverse investments the closer that year gets. Another tidbit I like is that GENERALLY, index funds perform better than mutual funds, so I’ve mixed those in as well.
Keep in mind that there are likely fees associated with what shares you buy/sell.
IRA or 401k – Put money in now, less taxes now. No touchy till you are 60 and you pay taxes on it later instead
Roth IRA – Put money in now, same taxes now. No touchy till you are 60, but when you withdraw you don’t pay taxes on the money or the gains.
In general a Roth IRA is a good idea when you believe you will be richer (and at a higher tax bracket) when you withdraw than you are now
Traditional IRA: you put money into it today and that money is taken off of your taxable income in the year which you make the contribution. The entire amount is taxed as income when you withdraw from it in retirement.
Roth IRA: you put money into it today but it does NOT reduce your taxable income up front (i.e., you pay the taxes on you contribution up front). When you withdraw the funds in retirement, you don’t pay any taxes on that money.
Traditional IRAs are good if you suspect your effective tax rate will be LOWER in the future than it is TODAY. Roth IRAs are good if you suspect your effective tax rate will be HIGHER in the future and/or you expect your investment gains would offset any tax advantages from the traditional IRA.
With a Roth, the key is that you put in money that you’ve already paid taxes on. Then, that money is invested in stocks, bonds, mutual funds, or whatever you choose ( or is recommended by someone you trust), & then, when you’ve reached retirement age, you have a large amount of invested & earned money, & owe no taxes on it.
If you start a Roth IRA at 30 years of age, you’ll have 30 or 40 years of saving & investing ahead of you. The money adds up significantly over that length of time, especially with compound interest on it as it grows. Saving for the future can be very satisfying. I recommend it.
In addition to most of the above explanations, you should know there are income limits. You can only contribute to a Roth IRA if your annual income is less than $144,000 for individuals or $214,000 for married couples filing joint taxes.
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