Retirement 101: IRAs And Roth IRAs

Written by on June 13, 2012 in Money - No comments | Print this page

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Planning for retirement

Retirement can be the best time of your life. But it takes planning.

401ks are the most common form of retirement plan.  Many businesses automatically set them up for their employers.  Other options are available though.  Individual Retirement Accounts (IRAs) and Roth Individual Retirement Accounts are the next two most common option.  Another option is a Roth 401k, but that is less common.

IRAs and Roth IRAs are very useful for those that do not have 401ks offered at their work, those that are self employed, and for those that put the maximum allowed into their 401k.  Contributing to both is a good idea for many people, but a 401k should always have enough contributed to meet an employers matching funds.

Before investing in either it is a good idea to understand what they are and how they work.  This article is meant as a primer for those interested in IRAs and Roth IRAs.

What are IRAs and Roth IRAs?
Both forms of IRA are like 401k plans in that they are retirement plans with special tax rules that enable a worker to plan for retirement.  The major difference between them and a 401k is that the 401k is a plan set up and ran by an employer, while an IRA or individual retirement account is set up and ran by an individual.  A 401k normally has an employer match, is automatically set up, and the business takes care of all maintenance.  Any form of IRA must be set up and ran by the individual that has it or someone they hire for that purpose.

There are many financial advisers and agencies out there that will help an individual set up their IRA.  Schwab.com is one such provider.  They have minimum investment requirements, there is no maintenance fee, and it should take no more than an hour to set up the account.

There are legal limits to the amount of money that can be invested in either one.  These limits are the same for both accounts.  These change year to year but in 2012 the limit was $5,000 with an additional $1000 for those over 50 years old.  The $5,000 and $6,000 are the legal maximum, but there is no requirement that says anyone has to deposit that amount.  It is estimated that an investment will double about every 8 years, so it is a good idea to invest even if it is just a small cash amount.


The rules for hardship withdrawals for both two retirement accounts are also the same.  Hardship withdrawals are times that the account holder can withdraw money from the account without paying penalties.  Home purchases, school expenses for the account owner and the owner’s children and grandchildren, medical bills and disability are just some of the reasons that a hardship withdrawal is allowed without paying tax penalties.

They also have the same rules for what constitutes a qualified withdrawal.  A qualified withdrawal does not have any penalties applied against it.  For a qualified withdrawal both require the owner to be older than 59.5 years old, and for any money invested to be in the account for at least 5 years before the withdrawal.

While there are many similarities it is their differences that make IRAs and Roth IRAs interesting.

Roth IRAs and IRAs handle taxes very differently.  When contributing to an IRA the contribution is reduced from taxable income.  That is if a person makes $40,000 a year, and puts $5,000 into an IRA their taxable income will only be $35,000 a year.  With a Roth IRA there is no tax break.  All many paid into a Roth IRA must have its taxes paid into it at the time that it is paid in.  The advantage of this is that the money put into a Roth IRA is the account holders free and clear.  There is no taxes or penalties that ever have to be paid on the money that is put in.  That does not apply to the earnings in the Roth IRA.  All earnings are subject to qualified withdrawal rules discussed above.

The Roth IRA is gaining in popularity because of another important tax difference.  Roth IRAs are not taxed when they are withdrawn.  There is never a tax for withdrawing the principal, as it is taxed before going into the account.  The earnings are not taxed for qualified withdrawals.  It should be stated again; the earnings for a qualified withdrawal are not taxed at all, ever. An IRA is tax deferred.  No money is taxed as it goes into the account, but it is taxed when distributed.  All of it is taxed when distributed the principal and the earnings.  An IRA is tax-deferred, while the earnings from a Roth IRA are tax-exempt.

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About the Author

Matt Brand

Matt Brand is QLR’s money saving expert. His experience with credit cards and student loans have made him take a strong interest in personal finance, saving money and sharing his knowledge. He is passionate about teaching others how to avoid the trap and make smart financial decisions. View all posts by Matt Brand.