An individual retirement account lets you take advantage of tax-sheltered growth, whether you use a traditional or Roth IRA. As a young investor, this lets you skip out on paying taxes on the gains in the account. There's no universal right answer to which IRA type is best for you as a young investor, but picking the right one for you can keep more money in your pocket after paying Uncle Sam.
If you desperately need a big tax refund, a traditional IRA is the way to go. Only traditional IRA contributions are deductible. If you are covered by an employer-sponsored retirement plan like a 403(b) or 401(k), you can't deduct your traditional IRA contributions if your modified adjusted gross income is too high. For example, in 2013, none of your traditional IRA is deductible if you're single, covered by an employer plan and your modified adjusted gross income exceeds $69,000.
If you're married filing jointly and covered, none of your traditional IRA contribution is deductible if your MAGI exceeds $115,000. Even if you can deduct your traditional IRA contributions, you might be sacrificing long-term tax benefits for a short-term gain because you'll pay taxes on the traditional IRA distributions. Roth IRA contributions are never deductible.
Future Tax Savings
If you expect to make it big eventually and pay a higher tax rate in your retirement years, you're likely to benefit more by contributing to a Roth IRA. You won't get a tax deduction for your contribution, but when you take qualified distributions at retirement you'll get the contributions and the earnings out tax-free. Let's say you fall in the 15 percent tax rate now but you expect to be in the 25 percent tax rate when you retire. When you contribute to a Roth instead of a traditional IRA, you give up the tax deduction when you fall in the lower bracket. But you may come out ahead in the long run because of tax-free distributions when you're in the higher bracket.
Generally, you've got to be 59 1/2 years old before you can take qualified withdrawals from a traditional or Roth IRA. As much a you're sure you won't need the money until then, a financial emergency can come up at any time, like a medical emergency or a down payment on your dream house. With a Roth IRA, you can get your contributions out tax- and penalty-free at any time. You only pay taxes and the 10 percent early withdrawal penalty when you start taking out earnings. With a traditional IRA, you can't take out all of your contributions first or avoid the taxes and penalties.
Both traditional and Roth IRAs require you to have compensation to contribute. With a traditional IRA, you also must be under 70 1/2 years old. You might have issues with a Roth IRA because the IRS caps who can contribute based on income. If your income is too high, you're not allowed to contribute for the year. In 2013, if you're single, you can't contribute to a Roth IRA if your MAGI exceeds $127,000. If you're married, the limit is $188,000.
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