It can often seem too early to start saving for retirement, but, in truth, it never is. Preparing yourself for the inevitable is very important. When it comes to having your finances in order before your income dries up, you’ll want to consider contributing to an Individual Retirement Account, also known as an IRA.
IRAs
If you’re paying taxes as an individual (i.e., not as a business), you have two types of IRAs to contend with: the traditional IRA and the Roth IRA. According to Investopedia, a traditional IRA allows for tax-deductible contributions. This means that when you add money to your account, that amount will be deducted from your income when your taxes are formulated. However, when you withdraw money from the account, the money will then be taxed as income that year. These accounts have limits as well: an individual under 50 can’t contribute more than $5,500 a year, for instance.
Roth IRAs work in the opposite way. Your contributions will not be deducted from your taxed income, but when you eventually pull money out of these accounts, you won’t need to pay taxes on that money. In both accounts, you also won’t owe taxes on the money accrued (so you’ll bypass the capital gains tax).
Which is best?
According to NerdWallet, the best choice depends on which tax bracket you expect to be in later in life. If you think you’ll have a lower tax rate later on, a traditional IRA will allow you to take advantage of those lower rates when you withdraw. If you expect to enter a higher bracket when you retire, a Roth IRA will spare you from paying higher taxes on withdrawn money, as you’ll be paying taxes at a lower rate up front and not paying any when it’s time to cash out. For the curious, a more in-depth comparison can be found here.
There’s also the issue of how to keep track of and manage your accounts. You can choose a cheaper, automated system or opt to hire a broker who will manage funds on your behalf. The second option is good for those new to investing, as you’ll be able to ask questions and gain a better understanding of how these accounts work.
Takeaway
It’s wise to keep track of your financial trajectory. Contributing money to a retirement fund is just one way to smartly prepare for the future. Because there are multiple options, you should take the time to educate yourself about them. Saving money may seem complicated at first, but once you’ve narrowed the options down, you’ll know what to do. Even if you decide not to invest right away, staying ahead of the curve and arming yourself with knowledge will never hurt.
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