Individual Retirement Accounts

Individual Retirement Accounts

February 19, 2024

The goal of this post is to share a few details about how Individual Retirement Accounts work, and the tax implications for them during accumulation and in retirement. This post does not include all of the rules and I intentionally omit some specific numbers such as contribution limits or withdrawal details since these are subject to change.

Traditional IRA – This is a tax deferred retirement account that is set up and run by an individual. A person with earned income (through gainful employment) in a calendar year can contribute to this account. Contributions to Traditional IRAs are pre-tax, meaning you are typically allowed to deduct the contribution on your tax returns for the year of the contribution. This saves money on taxes for this year and effectively move taxes owed out to the future. As the money in the account is invested and grows, there is no tax bill for dividends, interest or capital gains. Taxes are finally paid in retirement, when the individual begins to withdraw the funds to use for retirement spending. These are taxed at ordinary income tax rates. Another important feature of these accounts is that once an individual reaches a certain age, there are minimum distributions that owner is required to withdraw each year, whether they want to or not.

Roth IRA – This is a tax-exempt retirement account that is set up and run by an individual. There are many similarities to Traditional IRAs, however there are also several differences. The tax-exempt status means that you are not allowed to deduct the funds on your current year tax returns. However, the good news is that once you contribute to this account, reach retirement age, and also hold the account for at least five years, you are allowed to withdraw funds, at any time and you will not owe any tax. Also, as the money is invested and grows over time there is no tax bill for dividends, interest or capital gains. One of the drawbacks is that contributions to Roth IRAs are subject to income limits meaning that once your income reaches a certain point, you may no longer be allowed to contribute.

To know which account is right for you, consult your financial professional regarding your specific circumstances.

Advisory Services Network, LLC does not provide tax advice. The tax information contained herein is general and is not exhaustive by nature. Federal and state laws are complex and constantly changing. You should always consult your own legal or tax professional for information concerning your individual situation.