Prepare for the future with an IRA.
This is the IRA you are used to hearing about. This classic IRA features:
- You may get a tax deduction of up to $6,000 in 2021, plus an extra $1,000 catch-up contribution if you are 50 or older. The tax deduction eligibility depends on your income and other factors.
- Earnings on a Traditional IRA are not taxed until withdrawn.
- Withdrawals of principal and interest are taxed when withdrawn, but the delayed taxation usually means a lower tax rate when made after retirement.
- Early withdrawals come with a steep penalty. Besides your regular income tax rate, the IRS assesses a 10% early penalty for withdrawals made before age 591/2.
A Traditional IRA is generally preferred for those who anticipate being in a lower tax bracket after retirement due to reduced income. If your place of employment doesn't offer a retirement plan, a Traditional IRA may be for you, too.
Roth IRAs may be a little less familiar than Traditional. These accounts feature:
- Contributions are NEVER tax deductible, but withdrawals from these accounts are tax free.
- Similar to Traditional IRAs, the maximum annual contribution into a Roth IRA is $6,000 (plus $1,000 if over 50).
- Eligibility to contribute to a Roth IRA is based on your income.
- Withdrawals at any time are tax and penalty free, although withdrawals of earnings before retirement are taxed and penalized with some strict exceptions.
Roth IRAs are generally for those who anticipate being in a higher tax bracket after retirement. If you might need access to money before retirement, this might be the account for you; however, any tax professional would generally discourage dipping into retirement savings.
coverdell education iras
Coverdell Education Savings Account (ESAs) work similarly to Roth IRAs, except the goal is saving up for a child's education expenses. The features of these accounts are outlined below:
- Contributions are not tax deductible, but withdrawals of principal and interest are not taxed if used for qualified education expenses.
- Up to $2,000 annually may be contributed per beneficiary. Be careful if a grandparent or other family member plans to open a Coverdell for your child. Coordination is necessary to avoid penalties. The $2,000 contribution limit is also phased out for high income taxpayers.
- Qualified education expenses include college expenses, of course, but also some elementary and secondary education expenses.
- A child can be a beneficiary of an ESA and a state 529 plan at the same time, and you can contribute to both.
- Funding is not allowed after the child reaches 18, but if the child does not use the funds, the account balance must be distributed once the beneficiary reaches age 30.
- Withdrawal of funds before age 30 for non-qualified expenses will result in a 10% federal penalty.