Traditional IRAs are tax-advantaged retirement accounts that enable individuals to save and invest money tax-deferred until retirement. Traditional IRAs provide individuals with more investment choices than 401(k) plans, including mutual funds and ETFs.
However, they do come with some downsides. In this article we’ll examine the differences between an IRA and a 401(k), as well as some important considerations when choosing an IRA provider.
Taxes are deferred
With a traditional IRA, taxes typically only become due when you withdraw funds during retirement. Contributions are made with pre-tax dollars while earnings grow tax-deferred.
As this makes saving easier for retirement when your tax bracket remains unclear in the future, remembering to pay taxes on investments is also key.
Withdrawals from an income tax rate that may be significantly reduced during retirement can be taxed at your income tax rate today, leading some people to invest in both Roth IRAs and traditional IRAs to take full advantage of tax benefits in both. It is essential that you make the appropriate choice for you; if need be consult a financial advisor who will assist with making that choice. A traditional IRA remains one of the most popular retirement savings solutions among workers as it offers flexible investment holding capabilities and can accommodate nearly any investment asset class.
Investment options are more flexible
Traditional IRAs provide greater investment options than most employer-managed 401(k) plans, giving you or your financial advisor more freedom in creating a diversified portfolio that fits in with both your risk tolerance and retirement goals.
Other than individual stocks, other ways of investing include mutual funds, exchange-traded funds (ETFs), or real estate. These forms of diversification tend to be less volatile than individual stocks and actively managed funds can even seek out higher returns than the general market.
Keep in mind that IRAs are designed as long-term retirement savings accounts and taking money out before age 59 1/2 may incur heavy financial penalties. To learn more about your retirement savings options, schedule a complimentary consultation with one of our financial experts.
You can withdraw your money tax-free
An Individual Retirement Account, or IRA, provides individuals with tax-advantaged savings and investment accounts that allow them to save and invest their income before tax. Contributions may be deducted up to certain limits depending on income level and whether or not there is already an eligible workplace retirement plan like 401(k). Withdrawals will generally be taxed at ordinary income rates unless used for qualified purposes.
Traditional IRAs provide numerous investment choices – CDs, mutual funds and stocks – which enable you to tailor your portfolio according to your risk tolerance and retirement goals. They may also allow penalty-free withdrawals in certain instances.
If you take money out of a traditional IRA before age 59 1/2, the proceeds must be subject to ordinary income tax plus a 10% penalty tax. There may be exceptions such as for first-time home purchases or medical expenses; moreover, minimum distributions from your account must commence by age 735.
You can borrow money from your IRA
IRAs are meant to help you save for retirement, so borrowing from them should not be done easily. But in certain situations, you may be able to withdraw and replace funds without incurring penalties; but remember this does not qualify as a loan! Be aware of all applicable rules.
Traditional IRAs allow you to invest in mutual funds and ETFs, which are professionally managed groups of stocks and bonds. You have the option of actively managed funds – where managers select stocks they expect will outperform market average performance – or passively managed funds, where investments track overall market trends.
IRAs can also be used to buy a home and cover higher education expenses, but must not be withdrawn before reaching age 59 1/2 for any reason – you will also have to pay taxes on any distribution made before then as well as an early withdrawal penalty of 10% on amounts taken out early.
