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Financial Literacy Month: 2012 Contributions for Your IRA

by on April 11, 2012

By Meghan Stewart

Welcome back for the third day of Retirement Roundup for Financial Literacy Month! We’re taking a look at your Individual Retirement Account (IRA) options. There are two basic types of IRA accounts – the traditional IRA and the Roth IRA. Both plans offer distinct advantages and most retirement experts will tell you to have one or the other in addition to your 401(k).

So what’s the difference?

  • Both accounts let you contribute the same amount – for 2012, up to $5,000 or $6,000 if you’re over age 50.

Traditional IRA

  • A traditional IRA has the advantage of giving you tax deductions each year you contribute. So if you contribute the maximum $5,000 to a traditional IRA, you can deduct that whole $5,000 when you’re calculating your adjusted gross income.
  • The minimum withdrawals are required on the account starting at age 70.5. There is a 10% penalty for early withdrawals made before 59.5, except in certain circumstances such as using the money for higher education or to buy a home.
  • When the money is withdrawn, you pay income tax on it at your regular income tax rate.

Roth IRA

  • Roth IRA contributions are not deductible, so it’s considered an after-tax contribution.
  • While you don’t get a tax break during your contribution years, what you do get are major tax breaks when you take the money out after age 59.5 – the money you put in as well as the earning can both be withdrawn entirely tax-free.
  • Another advantage is you don’t even have to start taking the money out at 70.5. You can leave it there and let it continue to grow. This is the only retirement account which allows you to do this. This is increasingly important, considering Americans are living longer and starting retirement later.
  • You still have to leave the money alone until you’re 59.5, otherwise you may incur penalties.
  • Roth IRA accounts are only available to people who have an adjusted gross income less than $120,000 (as an individual); married couples are eligible up to $176,000. 

How do IRA contributions grow?

With both IRA account types, you usually have more options when it comes to what you do with the money than you do with a 401(k). You can do a money market account as a highly conservative retirement investor, which is effectively almost like a savings account, where you keep the money in cash and let it grow. You can also choose to invest in long-term CD’s, bonds, equity funds, or even stocks. You can even transfer money within your IRA to change your investment strategy – either put it into higher yield investments to earn a greater return or keep it in your money market account in times like these where the economy is so uncertain.

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