One of the main types of IRAs is the traditional kind. But being a newbie, I am not privy to knowing what is traditional.
It seems the tradition of Traditional IRAs is that the taxman favors these accountholders. And when I say favors, I mean the taxman ignores the funds in the IRA account and doesn’t tax the $$ until withdrawn. The taxman is doing his favorites a favor, saving them $$.
A deposit into an IRA account is not taxed. Since we are under 50, we can contribute $5,500 each year (FYI this # sometimes changes) to our Traditional IRA.
Once the money is in the account, I will invest it as I see fit. There are no penalties for buying and selling investment vehicles within the account. Plus, the taxman does me another favor,capital gains are not taxed each year, only in the long run.
The taxman will catch up with me when I’m old (59 1/2 +) and withdraw the money. Ideally, my tax bracket when I’m old will be lower than it was at the prime of my life (AKA now). By asking a bit less of me, the taxman is rewarding me for saving for retirement.
But watch out, the taxman will punish me if I withdraw money from my Traditional IRA pre- 59 1/2. The punishment includes taxing the withdrawal and a penalty too. Ouch, that’s harsh.
Watch this Khan Academy video explaining Traditional IRAs and how accountholders save $$.
Psst…Roth IRAs are seemingly similar, yet the exact opposite of Traditional IRAs. I’ll explain later this week. Just focus on figuring out the tradition of Traditional IRAs.
(Originally published on Amanda Stanhaus’s financial literacy blog: XO, Bettie.)