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I know some of us are a long way off (myself included) from this scenario but let’s say for a minute, hypothetically, that you’ve got all of your high interest debt (like credit cards) paid down, your low interest debt (like students loans or car payments) under control, at least, and you put some of each paycheck away in both a high yield savings account and your office’s 401k.

I know, I know - you’re thinking “yeah right, that’ll never happen” but rest assured some day (soon) it will. And when that time comes, it might make sense to put more money away in an IRA.

photo credit: estherase

An Individual Retirement Arrangement (sometimes called an Individual Retirement Account), is a personal retirement savings plan available to anyone who receives taxable compensation during the year. Best of all, money may be withdrawn from an IRA at any time (but on withdrawal it may be taxed and/or penalized).

While there are technically 11 types of IRAs you will likely choose between the two most common: a Traditional or a Roth IRA. What are the differences?

Traditional IRA:

• The tax breaks for a traditional IRA are tax-deductible. That means that the money you deposit in your IRA isn’t taxed. And regardless, whatever earnings you have on your contributions won’t be taxed until you withdraw that money many years later.
• If you withdraw the funds before age 59 1/2, then in most cases you’ll have to pay both income tax and a 10% penalty on whatever earnings have accrued — but if the funds are used to pay for “qualified higher education expenses” then the penalty will be waived.
• You can put just about any money from anywhere into a Traditional IRA account.

Roth IRA:

• Unlike a contribution to a Traditional IRA, a Roth IRA contribution is never deductible. However, when you withdraw the money from a Roth IRA, none of it — and that includes the earnings — will be taxed (assuming that the Roth IRA has been open for at least five tax-years and you are older than age 59 1/2).
• A Roth IRA gives you huge flexibility by allowing you, in many cases, to withdraw your principal contributions at any time tax-free, without penalty. For instance, first-time homebuyers can pull out $10,000 in profits penalty free and tax-free (again, if the money has been in the Roth IRA for at least five tax years). There are also some breaks for education spending, and others.

So, which is the best option for you? That depends on a lot of different factors. But luckily there are plenty of online calculators to help you through the decision-making. Mint.com offers an easy three-step IRA Advisor and Fool.com has a number of different calculators in their Roth IRA center.

Just remember, whichever you choose, you’d better hurry. The deadline to sign up using your ‘07 taxes is April 15^th! Is it worth it? Well, By opening an IRA today, you could save up to $1,200 on your 2007 taxes. And, without any work or risk on your part, a $4,000 contribution this year could grow to as much as $65,000 in 35 years!

sources: - “Traditional vs Roth IRA: Which IRA Is Right For You?” [blog.mint.com]
               - “All About IRAs” [Fool.com]

Technorati Tags: personal finance, money, IRA, Roth IRA, Traditional IRA, saving, career, college, graduation, real world

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