The acronym IRA stands for an Individual Retirement Account. On dictionary.com, an IRA is, “an investment account in which a person can set aside up to a specified amount each year and usually deduct the contributions from taxable income, with the contributions and interest being tax-deferred until retirement.” This definition is for a Traditional IRA.
Alternatively, a recent development has been the Roth IRA. This type of IRA functions similarly to a Traditional IRA – with one main exception. Instead of contributions being tax deferred, you contribute to a Roth IRA with after-tax dollars. Again, according to dictionary.com, a Roth IRA is where you make contributions for retirement but “earnings on the account are tax-free, and tax-free withdrawals may be made after age 59-1/2.”
So, which type of IRA is better? To know for sure, you’d need a crystal ball – you know your income tax rates now, but can you project what they will be in the future at the time of withdrawal? In general, if you believe your income tax rate now is higher than it will be at retirement, than a Traditional IRA is probably best for you. Alternatively, if you believe your income tax rate now is lower than it will be at retirement, a Roth IRA is probably best. Tax treatment and eligibility for either type of IRA phase out at certain levels of income. So, as always, when making these types of decisions, seek the advice of an investment professional.
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