The difference between a 401(k) and an IRA is right there in that first letter — “I” for individual. Anyone can open an IRA; it doesn’t need to work through your employer. Of course, you’ll be the only one contributing to your IRA. There are multiple types of IRAs to consider based on your financial situation.
A traditional IRA lets you contribute money in a similar, tax-deferred fashion as a traditional 401(k). In most cases, the income you contribute to your IRA is tax-deductible (or at least partially tax-deductible, depending on your income level), so you may be able to save money on your taxes. This also lets you invest a larger amount of money earlier on, so that you can earn more in interest over time.
When you make withdrawals during retirement, the money is taxed as ordinary income. And remember, you can have both a 401(k) and an IRA, so if you’ve already hit your 401(k) contribution, you can still continue your retirement saving in your 401(k).
At age 72, you’re required to start taking IRA distributions (making withdrawals from your IRA). You’ll have to take out at least a minimum amount each year to avoid tax penalties. That’s why it’s important to start contributing to your IRA early so you can take advantage of as many years of compound interest as possible before you start making withdrawals.
A Roth IRA is taxed differently than a traditional IRA. Your income is taxed as you earn it based on your current tax bracket. Your contributions aren’t tax deductible now. However, you avoid paying taxes on your earnings (such as capital gains taxes). When you withdraw the money, it’s tax-free.
There are no age limitations or mandatory withdrawals for a Roth IRA like you’ll find with a traditional IRA. If you want to leave your money in your Roth IRA for a few additional years to earn additional interest, you’re welcome to. Or you can withdraw it if you need it.
But you’re only eligible to contribute to a Roth IRA if you fall below set income thresholds. The income limit for Roth IRAs in 2021 is between $125,000 and $140,000 for single individuals — with higher caps for married couples — meaning that if you make more than that, you’ll either be ineligible to make Roth IRA contributions or you’ll be capped at a reduced amount.
For both Traditional IRAs and Roth IRAs, contributions are limited to a maximum of $6,000 per year. After age 50, you can contribute up to $7,000.
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