An individual retirement account allows you to save for life after work with some helpful tax advantages. If you're considering a new IRA, you'll have to pick between a traditional version or a Roth. While a traditional IRA allows you to deduct contributions from taxable income, a Roth allows tax-free withdrawals later on.
In some ways, traditional and Roth IRAs treat your money the same. Gains realized by either type of account are tax-free before you withdraw any funds, and while assets accumulate. Another key similarity: while you can open more than one IRA, both Roth and traditional set a contribution limit of $5,500 among all accounts, while those over 50 can add a $1,000 "catch-up" contribution each year. You can't contribute more than your taxable income during the year.
Not everyone can open a Roth IRA. As of 2015, they were only available to single tax filers with adjusted gross incomes under $131,000. For married filers, the income cap was $193,000. The IRS rules also limit contributions for those coming in slightly under the income limits. There are no income limits on traditional IRAs, which are available to anyone with earned income.
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The IRS requires distribution of traditional IRA assets beginning at age 70-1/2. You must take a required minimum distribution each year, with the amount depending on your age and life expectancy. Roth IRAs have no required distributions--you can keep the money in account as long as you like regardless of age.
With a traditional IRA, the IRS will slap a penalty on withdrawals taken before age 59-1/2. Unless the withdrawal is for a certain "qualified" purpose, such as a first-time home purchase or emergency medical expenses, the 10 percent penalty comes on top of any taxes due on the account's earnings. Roth IRAs allow penalty-free withdrawal of your original contributions at any time, and penalty-free withdrawal of account earnings after the account has been open for five years, or after you turn 59-1/2.
Rules for Beneficiaries
Many IRAs survive the deaths of their owners, and for that reason you must choose a beneficiary when you set one up. If the IRA passes to a non-spouse, that individual must take required minimum distributions from the account each year. He must start by December 31 of the year following the original owner's death. A spouse can roll the funds over to his own IRA and wait on distributions until he reaches age 70-1/2. The tax-free withdrawals on a Roth are available to a beneficiary, as well--unless the account's been open for less than five years. If you're inheriting an IRA, or any kind of retirement pension, consult a financial planner who knows the rules.