How an IRA Differs From a Roth IRA

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There are a lot of differences, and even more similarities, between a traditional and Roth IRA, but the key factor in how the two differ is in your future, and current, tax obligations.

An IRA is an independent retirement account, which means you set the account up on your own and maintain it on your own, whereas a 401k is set up through your employer. You can go to a financial institution and with the help of a financial adviser, or your own knowledge, choose every detail on how your money will be invested. This is true with either type of account.

A traditional IRA, in terms of taxes, is set up very similarly to a traditional 401k. Your contributions to the account are taken from your income before taxes are taken out. The percentage of your income that you owe to taxes each year changes depending on your income bracket. If you make less money you pay a smaller percentage of your income to taxes. Because your contributions are taken out before taxes are taken out your income level lowers, which may lower you down to a lower tax bracket, meaning you owe less money in taxes this year. When you withdraw from your account after you reach retirement age that you'll then be paying taxes on this money. So, if you believe you will be withdrawing small amounts of money/having a lower income in retirement, then you may prefer to put off paying taxes on this income until you reach retirement age.

With a Roth IRA your contributions are taken from your income after taxes are taken out. When you withdraw from your account after reaching retirement age you will not be paying taxes on your withdrawals. This means that you are paying taxes on that income now.

Of course, it can be hard to feel confident about what your income level will be in retirement, or in any of your investment decisions. For more answers you can always talk to a financial professional, or read more to better understand your options. Don't let this fear stop you from investing, however, because the most important thing is simply that you are saving for retirement.

Knowledge is power, become more informed about all your options by visiting 401K to IRA for all the information you need, including information about retirement balances, cashing out, and the 401k early withdrawal penalty.

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