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What Millennials Need to Know About Traditional vs Roth IRAs

Contributing to an IRA is an effective way for people of all ages to create wealth for later in life. Those who choose to open an IRA have the option of opening a traditional or a Roth account. Many financial planners say that having one of each may be best for minimizing income tax both now and in retirement.

What Is the Tax Treatment for Each Type of Account?

When you contribute to a traditional IRA, you get a tax deduction in the year that the contribution is made. The money grows tax-free until it is withdrawn, and there is a 10 percent penalty for making a withdrawal before age 59 1/2. You will also be required to take mandatory distributions once you reach age 70 1/2. With a Roth IRA, the money grows tax-free and can be withdrawn tax-free. This is because there is no tax deduction in the year when the contribution is made. You can also withdraw any contribution that you make without penalty at any time, which may be better than applying for a bad credit loan.

There Are Income Limits for Roth IRA Contributions

Whether you have a traditional or Roth IRA, you can contribute $5,500 per year. This number increases to $6,500 if you are over the age of 50. However, with a Roth IRA, you cannot make contributions if you make more than $132,000 as a single filer. The amount that you can contribute to a Roth IRA is reduced for single filers making between $117,000 and $131,999.

Can You Get Around These Income Limits?

There is one option to get around the income limit and it begins by opening a traditional account. Once you have put money into that account, you can then convert it to a Roth IRA. While you will need to pay tax on whatever you rollover when you move it to the new account, there are otherwise no restrictions on how much money that you can transfer.

Why Should I Have More Than One IRA?

You are allowed to have as many IRA accounts as you want as long as you don’t surpass your yearly contribution limit. The benefit of having a traditional account is that it provides a guaranteed tax break today. In theory, rules changes to Roth accounts could reduce or negate any future savings that you anticipate several years from now. Contributing to a traditional account may also put you in a lower tax bracket. That reduces your tax burden, which may provide more money to put in the bank or contribute to your Roth IRA.

What If I am Self-Employed?

A self-employed person is allowed to open an IRA and fund it with money made through freelance work or other jobs completed as an independent contractor. A self-directed IRA may make it easier to invest in gold, small businesses or other opportunities that may not be available for those with typical accounts. Those who work for themselves may also choose whether an account will be a traditional or Roth variety.

It is never too early or too late to start thinking about retirement. You can generally open an IRA in your own name when you turn 18, which means that most millennials should be able to start putting money away for retirement right away. If you have questions about what type of account is best for you, it may be worthwhile to talk with a financial adviser.

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