Most of the benefits of an IRA come into play during retirement, seeing as this is when you can start drawing money from the account. You can contribute to an IRA your entire working life but the key benefit of one only comes into play when you’re done working.
But that doesn’t mean there’s no benefits to contributing to an IRA when you are working.
So what are the benefits of contributing?
Those holding and contributing to a Traditional IRA can deduct their contributions to it from their taxable income. The person contributing can put in a maximum of $5,500 a year (indexed for inflation), and can deduct that amount from their taxable income.
Because you are deducting your contributions from your income, it means you are paying with before-tax dollars. This makes the growth more substantial in the account since you can put more into it without it being taxed in advance.
What if I have a Roth IRA?
Unfortunately for those contributing to a Roth IRA, you cannot deduct contributions from your income for tax. These contributions are made using after-tax dollars, meaning the growth in the account will be less substantial.
So why would I contribute to a Roth IRA?
Just because you can’t deduct the contributions to a Roth IRA from your income doesn’t mean this type of account doesn’t have any benefits.
Because you are paying into a Roth with after-tax dollars, you receive the distributions from the account tax free. This means that you pay tax to have the contribution entered into the account, but it grows completely tax free.
What you see in the account is completely yours, not the government’s.
So should I contribute to a Roth or Traditional IRA?
The answer to this question is going to come down to your income goals, your expectations of the growth in the underlying investments in the account, and whether you would rather save money on tax now or in the future.
A good alternative to choosing a Roth or a Traditional IRA is to choose both, which is something we will cover in a later post.
Disclaimer: The information on this page should not be construed to be financial advice. For advice regarding your specific situation, please contact your local financial advisor.