As you consider your retirement fund, you have probably heard the term Roth IRA as an investment option.
In this article, we will help you understand what a Roth IRA is and how it differs from a traditional IRA.
Let's first take a look at the idea of IRAs in general.
IRAs were constructed in 1974 as a way for you to save money for retirement without being inhibited by significant taxation in the process.
Thus, with the original IRA--now called the traditional IRA- you could contribute money to your IRA fund tax free.
What does this mean? It means that you if you earn $70,000 dollars annual, and you contribute $5,000 dollars to your IRA (the current maximum), you will only be taxed on $65,000 instead of your full salary.
Thus, your traditional IRA contribution is tax free.
The benefit of the IRA is truly realized though as the years accumulate and the idea of compounding money takes effect.
If you contribute the maximum $5,000 for 30 years leading up to retirement, your $150,000 of total contributions (if we assume a growth rate of 8%) are magically compounded into more than $600,000 dollars.
After you retire, you will then pay taxes on this money as you take it out.
So, then, what is a Roth IRA and how does it differ from a traditional IRA? Both forms of IRA accounts realize the true value of compounding money in the same way.
The principal difference comes in how you are taxed.
As stated, with a standard IRA you are not taxed when your put the money in--your contribution--but you are taxed when you take the money out.
The Roth retirement account works the exact opposite.
In other words, your initial contribution is after-tax money, but you pay no tax later in life when you withdrawal the money.
If we continue with the example above, and contribute $5,000 a year for 30 years, we pay tax on that $150,000 that we have put into our Roth account.
However, we pay no tax on the $600,000 as we take it out.
For most people, a Roth IRA provides greater benefits than a traditional IRA.
Initially, it seems like the differences would be substantial.
However, we need to remember that we saved money in the traditional IRA on the money we contributed because we did not have to pay tax on it.
If we assume the same 8% rate of return on the money that we saved, this number results in a return greater than $100,000.
Thus, our retirement account would have a greater value when we retire, but we would have to pay tax on the money as we take it out.
This generally makes the Roth IRA more appealing.
One other important thing to note is that you need to find the best Roth IRA for you.
This may be your bank, but it is better to open your Roth IRA with a mutual fund company or brokerage firm.
The Roth IRA best rates are achieved by choosing the best place to place to put your money and choosing the proper level of risk.
Whichever investment vehicle that you choose--the traditional IRA or the Roth IRA, you are sure to realize a tremendous value when you retire.
The principle of compounding takes affect in both types of IRAs and leaves you with much more money that you initially contributed!
In this article, we will help you understand what a Roth IRA is and how it differs from a traditional IRA.
Let's first take a look at the idea of IRAs in general.
IRAs were constructed in 1974 as a way for you to save money for retirement without being inhibited by significant taxation in the process.
Thus, with the original IRA--now called the traditional IRA- you could contribute money to your IRA fund tax free.
What does this mean? It means that you if you earn $70,000 dollars annual, and you contribute $5,000 dollars to your IRA (the current maximum), you will only be taxed on $65,000 instead of your full salary.
Thus, your traditional IRA contribution is tax free.
The benefit of the IRA is truly realized though as the years accumulate and the idea of compounding money takes effect.
If you contribute the maximum $5,000 for 30 years leading up to retirement, your $150,000 of total contributions (if we assume a growth rate of 8%) are magically compounded into more than $600,000 dollars.
After you retire, you will then pay taxes on this money as you take it out.
So, then, what is a Roth IRA and how does it differ from a traditional IRA? Both forms of IRA accounts realize the true value of compounding money in the same way.
The principal difference comes in how you are taxed.
As stated, with a standard IRA you are not taxed when your put the money in--your contribution--but you are taxed when you take the money out.
The Roth retirement account works the exact opposite.
In other words, your initial contribution is after-tax money, but you pay no tax later in life when you withdrawal the money.
If we continue with the example above, and contribute $5,000 a year for 30 years, we pay tax on that $150,000 that we have put into our Roth account.
However, we pay no tax on the $600,000 as we take it out.
For most people, a Roth IRA provides greater benefits than a traditional IRA.
Initially, it seems like the differences would be substantial.
However, we need to remember that we saved money in the traditional IRA on the money we contributed because we did not have to pay tax on it.
If we assume the same 8% rate of return on the money that we saved, this number results in a return greater than $100,000.
Thus, our retirement account would have a greater value when we retire, but we would have to pay tax on the money as we take it out.
This generally makes the Roth IRA more appealing.
One other important thing to note is that you need to find the best Roth IRA for you.
This may be your bank, but it is better to open your Roth IRA with a mutual fund company or brokerage firm.
The Roth IRA best rates are achieved by choosing the best place to place to put your money and choosing the proper level of risk.
Whichever investment vehicle that you choose--the traditional IRA or the Roth IRA, you are sure to realize a tremendous value when you retire.
The principle of compounding takes affect in both types of IRAs and leaves you with much more money that you initially contributed!