An individual retirement account is a savings account, also known as IRA. IRAs are savings plans that have a lot of restrictions. One of the main advantages of individual retirement accounts is that you can postpone paying taxes on your earnings and savings growth until you withdraw the money.
There is always a negative aspect present for all good ones. According to that, IRAs have the disadvantage of imposing tax law penalties when you withdraw money before you turn 59.5 years old. Several kinds of IRAs exist such as Traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. Each individual retirement accounts has its own tax implications and eligibility criteria.
Three main types of IRAs:
Traditional IRAs:
Here, you can check out the key features of traditional individual retirement accounts.
- You can get a tax deduction for the savings that you contribute to your account. This kind of deduction reduces your taxable income.
- The savings also grow tax-deferred, which means you would not include dividends, interest, or capital gains from the accounts in your annual income.
- If you withdraw money, distribution from account included in your taxable income is taxed as ordinary income.
- Before you reach the age of 59, if you withdraw funds, then it can include extra 10 percent tax.
Nondeductible Traditional IRAs:
It is a traditional IRA, but the contributions are not tax-deductible. Savings are also tax-deferred. If you start taking a distribution, part of that distribution will be treated as a tax-free return, while the rest will be taxed as ordinary income.
Most people adopt this kind of individual retirement accounts when they find themselves in a specific financial situation. The primary difference for both nondeductible and traditional IRA is the tax against original contribution.
Roth IRAs:
This offers potential tax-free distributions as well as savings. Not like a traditional IRA, this type of IRA does not put any deduction on your contributions that are not tax-deductible. Savings increase without paying any taxes on the growth and earnings. It has certain income limitations and minimum distribution criteria to apply for Roth IRAs.