The IRA or the individual retirement account is a retirement plan with tax benefits (money invested in a traditional IRA is tax exempt to a certain extent). It was developed in the United States in the year 1974. IRA plans are either self-funded or employer-funded and are operational under the tax laws of the United States.

There are various types of IRAs - Roth IRA, traditional IRA, SEP IRA (Simplified Employee Pension Individual Retirement Account), simple IRA and self-directed IRA. There are a couple of variations of IRA as well, namely the Conduit IRA and the Rollover IRA.

The Roth IRA is different from other IRAs. The benefits, tax rebates and income restriction clauses of Roth IRAs are all different from traditional IRAs. It was named after its chief sponsor, Senator William Roth and is governed by specific eligibility and filing status norms propounded by the Internal Revenue System. The investment in any individual retirement account should never exceed the AGI (adjusted gross income) and the Roth IRA is no exception.

For a close Canadian equivalent to the IRA and Roth IRA, see RRSP vs TFSA.

Comparison chart

IRA versus Roth IRA comparison chart
Edit this comparison chartIRARoth IRA
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Plan set by Individual Individual
Contribution Limits $5,500/yr for age 49 or less; $6,500/yr for age 50+; limit is for combined contributions to traditional IRA and Roth IRA. $5,500/yr for age 49 or less; $6,500/yr for age 50+; limit is for combined contributions to traditional IRA and Roth IRA.
Income Limits Based upon MAGI; Single, HoH, MFS: full contrib to $61,000, partial to $71,000; MFJ; QW: full contrib to $98,000, partial to $118,000. Can't contribute more than you earn in that year. Based upon MAGI; Single, HoH, MFS: full contrib to $117,000, partial to $132,000; MFJ; QW: full contrib to $184,000, partial to $194,000. Can't contribute more than you earn in that year.
Employer contributions Rarely No
Investments in the account Stocks, Bonds, Mutual Funds, Real Estate (Only in specific types of IRA's). Capital gains, dividends, and interest within account incur no tax liability. Stocks, Bonds, Mutual Funds, Real Estate (Only in specific types of IRA's). Capital gains, dividends, and interest within account incur no tax liability.
Tax Implications Contributions may be tax-deductible subject to income limits. Gains in the account are not taxed. Distributions from the account are considered ordinary income and taxed accordingly. Contributions are never tax-deductible. Gains in the account are not taxed. Distributions from the account are tax-free.
Distributions Distributions can begin at age 59½ or owner becomes disabled. Distributions can begin at age 59½ as long as the account is at least 5 years old; or if owner becomes disabled.
Forced Distributions Must start withdrawing funds at age 70½ unless employee is still employed. Penalty is 50% of minimum distribution No such restrictions or forced distributions.
Borrowing against Account No No
Early Withdrawal 10% penalty plus taxes for distributions before age 59 1/2 with exceptions. No penalties on early withdrawal up to the amount of principal contribution.
Early Withdrawal for Medical Expenses Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability
Early Withdrawal for Homebuyers Can withdraw (without the 10% tax penalty) up to $10,000 for a first time home purchase down payment with stipulations Can withdraw (without the 10% tax penalty) up to $10,000 for a first time home purchase down payment with stipulations
Early Withdrawal for Educational Expenses Can withdraw without the 10% tax penalty for qualified education expenses of owner, children, and grandchildren. Can withdraw for qualified unreimbursed medical expenses that are more than 7.5% of AGI; medical insurance during period of unemployment; during disability
Conversions Can be converted to a Roth IRA. Taxes need to be paid during the year of the conversion. Other limitations may also apply. A Roth IRA cannot be converted into a traditional IRA.
Withdrawals Taxed as ordinary income (distributions from Roth IRAs are not taxed) Tax free
Posthumous benefits There are no posthumous benefits. Penalty free benefits are provided posthumously.
Changing Institutions Funds can be either transferred to another institution or they can be sent to the owner of the traditional IRA who has 60 days to put the money in another institution in a rollover contribution to another traditional IRA. Funds can be either transferred to another institution or they can be sent to the owner of the traditional IRA who has 60 days to put the money in another institution in a rollover contribution to another traditional IRA.

Taxability

One of the biggest differences between traditional IRA and Roth IRA lies in their tax treatment. Investments in a Roth IRA can be withdrawn at any point without incurring a penalty or additional taxes.. This can also be done after the conditional age of 59.5 years is attained. Withdrawals from a traditional IRA, on the other hand are taxed like ordinary income. Also a penalty is charged, should you want to withdraw before the age of 59.5 years.

Contributions to a traditional IRA are tax deductible, subject to income levels. Whereas, contributions made to a Roth IRA is not tax-deductible. Therefore, a contribution to Roth IRA does not reduce the AGI (Adjusted Gross Income) of a person whereas investment in traditional IRAs reduces the AGI of the tax payer. Legal contributions can be made to both a traditional IRA and a Roth IRA even if the individual is enrolled in any other retirement plan, like a 401(k).

Distributions

Roth IRAs offer the benefit of flexibility in terms of distribution age limits. In case of traditional IRAs, the distribution starts at the age of 59.5 years and becomes mandatory by the age of 70.5 years.. There are no such restrictions in a Roth IRA.

Income Restrictions

The traditional IRA has no income restrictions, everyone can invest in them. However, you cannot invest in a Roth IRA if your income is over $95,000 a year (single) or $150,000 (married couple).

Other benefits

If the owner of a Roth IRA dies, the spouse becomes the sole heir of the policy, even if he/she is already holding another Roth IRA. Both the accounts can be combined together and one single account can be formed without any extra penalty. These facilities do not come with a traditional IRA.

References

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