IRA's: what's best for you?

When you graduate, your employer encourages you to save for retirement through the 401(k) which I discussed last week. However, the government also offers two tools that encourage retirement savings. The IRA or independant retirement account provides a tax shelter for your retirement savings. There are two types: the Traditional IRA and the Roth IRA.

The Traditional Ira:

• Tax deductible contributions (depending on income level)
• Withdraws begin at age 59 1/2 and are mandatory by 70 1/2.
• Taxes are paid on earnings when withdrawn from the IRA
• Funds can be used to purchase a variety of investments
• Available to everyone; no income restrictions
• All funds withdrawn before 59 1/2 are subject to a 10% penalty (subject to exception).

Roth IRA:

• Contributions are not tax deductible
• No Mandatory Distribution Age
• All earnings and principal are 100% tax free if rules and regulations are followed
• Funds can be used to purchase a variety of investments
• Available only to single-filers making up to $95,000 or married couples making a combined maximum of $150,000 annually.
• Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).

The biggest difference between the Traditional and Roth IRA is how the monies inside them are taxed. If you earn $60,000 a year and put $2,000 in a traditional IRA, you will be able to deduct the contribution from your income taxes (meaning you will only have to pay tax on $58,000 in income to the IRS). At 59 1/2, you may begin withdrawing funds but will be forced to pay taxes on all of the capital gains, interest, and dividends that were earned over the past years.

Iif you put the same $2,000 in a Roth IRA, you would not receive the income tax deduction. There are no penalties for withdrawing principal at anytime. When you reach retirement age, you will be able to withdraw all of the money 100% tax free. The Roth IRA is the best tool the government provides, however unfortunately not everyone qualifies for a Roth. A person filing their taxes as single can not make over $95,000, but as a recent college graduate you will most likely qualify. It is a great tool to use to save for retirement and as long as you are eligible I urge you to contribute as much as you can.

You can generally purchase any type of investment you would like, either through a brokerage account or a bank. Unlike a 401(k), you can choose any investment offered through the bank or brokerage firm rather than just those funds offered by the adminstrator of the 401(k). This includes index funds, exchange traded funds, or mutual funds.