Traditional vs. Roth IRA

Our country is in huge debt. The last time I checked, the national debt is $12,814,623,586,024 according on usdebtclock.org. Everybody is speculating that Social Security will run out soon since millions of baby boomers are about to cash in on their retirement money. So that leaves some of us wondering what can the younger generation do now to ensure they're financially covered at their retirement age. Well, an easy answer would be winning the Mega Millions jackpot. That has always been my personal goal. Otherwise, just do what everybody else does - work hard and save up. Bare in mind that checking accounts don't earn you interest, savings accounts earn you around1% and even CDs earn you around 1% only these days. Guess what? You still have to pay tax on the ridiculously small amount of interest you earn at the end of the year as income. You can do more towards your retirement than that. How about an IRA?

If your company currently does not offer a retirement plan, I would recommend getting one from a financial institution. There are two options: Traditional IRA and Roth IRA. Both will allow you to contribute, use those money to invest and make some money towards retirement. Keep in mind that you can also have IRAs even if you already have a retirement plan through your company.

Traditional IRA is tax deferred - you don't pay tax on the amount you contribute right away. In fact, you don't have to pay tax on your contribution and earning (money you earned from investing your contribution) until you withdraw the money at your retirement age. When you are ready to withdraw, the withdrawal will be taxed as regular income based on your tax bracket at that time. There are certain rules to traditional IRA such as the minimum age for withdrawal from the account is 59.5 years old, mandatory gradual withdrawal at age 70.5 (because uncle Sam wants you to pay the tax you owe them for last however many years), and you will get penalized if you withdraw before 59.5 years old. The assumption of this whole traditional IRA is that your tax bracket at your retirement age will be lower than your tax bracket now since you probably won't be working when you reach retirement age. Thus, you won't be making as much income as now and you will have a lower tax bracket. This essentially is a way to avoid paying certain portion of your tax to the government now.

Roth IRA is not tax deferred - you contribute after tax money. The good thing about it is that you have the flexibility of withdrawing your contribution anytime you want (this is not the case with traditional IRA). Withdrawal of the earnings is tax free after 59.5 years old. You will get penalized if you withdraw the earning earlier than that.

Both types of IRAs have contribution limits. For 2010, the maximum you can contribute is $5000 (after tax for Roth and before tax for traditional).

IRAs are so popular nowadays that it's so easy to find a financial institution that offers them. Vanguard, Fidelity, Ameriprise, John Hancock just to name a few. All major banks offer them too. But make sure you shop around because every institution offers general investments as well as their proprietary investments including bonds, stocks and mutual funds. After you open an account, you just have to decide how to invest your contribution and you'll be on your way to grow a money tree towards your retirement.