What Are My Options with an IRA Account?
- When you contribute money to a traditional IRA, you can deduct the amount you contribute when you prepare your taxes. That lowers your taxable income, as well as your tax liability. A traditional IRA is a good choice if you expect to be in a lower tax bracket when you retire, since the value of the tax deduction is dependent on your current tax bracket. You do have to pay taxes on the money you withdraw in retirement, but since you will be in a lower tax bracket, the tax hit should be much less.
- With a Roth IRA, you cannot take a tax deduction. But in exchange for giving up that tax deduction, you have the opportunity to withdraw your Roth IRA proceeds tax-free when you retire. That stream of tax-free income makes the Roth a good choice for workers who expect taxes to rise in the future, and those who expect to be in a higher tax bracket when they retire. As of 2011, you can put up to $5,000 in either a traditional or Roth IRA, plus an extra $1,000 if you are at least 50 years of age.
- If you are self-employed or run a small business, you can open an SEP-IRA and use it to lower your tax liability. This is an important consideration, since self-employed individuals and business owners face higher taxes than regular wage earners. For 2011, you can contribute up to $49,000 to a SEP-IRA, but the actual amount you can contribute is based on your earnings. You can use a SEP-IRA calculator to calculate your maximum SEP-IRA contribution.
- Deciding which IRA to invest in can be a real challenge, but running the numbers ahead of time can make the decision a lot easier. You can use any one of the popular tax preparation software packages to run various scenarios with both traditional and Roth IRA accounts. If you have income from a business or self-employment, you also can see how contributing the maximum amount to your SEP-IRA can reduce your tax liability.