There are two types of long-term investment accounts. They are Individual Retirement Account-IRA-- and Education Saving Account--ESA. These accounts are very beneficial for those individuals who have long-term horizons in their investments. These accounts offer income tax advantages to the investors besides building wealth over long time.
Individual Retirement Account-IRA
An Individual Retirement Account is a personal retirement savings account that offers tax benefits to the investors. It allows them to deposit a part of their income into a tax deferred brokerage account. To explain it further, you are given the benefit of tax deferment when your earnings accumulate without having to pay taxes on them. You have to pay taxes when you start withdrawing the money.
You get two benefits from this provision. First, the growth of your money will be tax-free. You get more to invest if you do not have to pay taxes immediately and also you will be in a lower tax bracket when you retire. You thus pay less in taxes on your withdrawals.
Contributions to this account may also be tax-deductible. For example, if your yearly salary were $ 45, 000 before taxes and you invest $2,000 a year into a regular IRA, you would deduct that $2,000 from the $45,000 and then leaving you with $43,000 in taxable income.
IRAs are of different types:
Traditional IRA
A Traditional IRA is a retirement account that permits the investors to defer taxes on their earnings until they start taking their money out. The money that the individuals invest is tax deductible in the year it is put in. The investors can participate up to the age of 70. They can presently contribute up to $4,000 every year. If you are 50 years old, you can contribute $5,000 every year.
If you contribute to the Traditional IRA, you do not have to pay any taxes on what you earn until you start withdrawing money. This is known as tax deferment. This type of account makes sense for the investors since by the time they retire; chances are that they will be in a lower tax bracket. It must be noted that if you are in a lower tax bracket you pay less in taxes on earnings from your IRA account when you retire.
You can make taxable distributions from a Traditional IRA beginning at the age of 59 without paying the penalties. The penalties, however, are levied on early withdrawals. If you withdraw your money before the age of 59, you have to pay a penalty of 10%. There can be exceptions to this rule, for example, penalty can be waived or reduced in case of owner's death or disability and also if you have to pay back taxes, buy a home for the first time, or, pay medical and higher education expenses.
Roth IRA
A Roth IRA is like a Traditional IRA. The only difference is that you pay taxes on the money you invest while your withdrawals are tax-free. Investors up to the age of 70 may currently contribute up to $4,000 every year. If you are 50, you can invest $5,000. If you think that you shall be in higher tax bracket when you retire, it is recommended that a Roth IRA can be a better retirement solution. A Roth IRA can allow your investment to grow tax-free. Five years after you invest, withdraws will not be taxed. After you have turned 59 or you can use your withdrawal for the first home purchase. Withdrawing early may attract a penalty of 10%.
Rollover IRA
"A Rollover IRA is a holding account. If you transfer funds or stock from a retirement plan such as a 401(k) or 403(b), the money or stock can stay in the Rollover IRA Account for a period of 60 days. The account owner controls the Rollover IRA account during those 60 days. After that, the funds need to be placed into another retirement plan. . A rollover may not be done more than once a year.
Education Saving Account-ESA
An Education Saving Account is a trust that is set up to pay educational expenses of the designated beneficiary who is generally a minor for whom the account is opened. This account must be opened before the beneficiary reaches the age of majority. The total contributions cannot exceed $2,000. The money must be distributed if the beneficiary reaches age of 30.
