Hedging Your Bets with a Roth IRA and Traditional IRA

Setting up a Roth IRA and traditional IRA is something that many investors are doing to basically hedge their bets as they get ready for retirement. An IRA allows you to set aside a certain amount of money into a retirement account without paying taxes on it. Here are the basics of investing in both types of IRA and how it could potentially benefit you. 

Traditional IRA

You can contribute a maximum of $5000 per year into an IRA without paying taxes on it. You then use the money to invest in securities such as stocks, bonds or mutual funds. The money that you make as a return on your investments goes back into the IRA without incurring any tax liability. Therefore, the money in your account can grow tax-free for the entire life of the IRA. When you reach the age of 59 1/2, you can then start withdrawing the money. At that time, you will pay taxes on the money as you take it out. 

Roth IRA

The Roth IRA is basically the same idea, except in reverse. It is still a retirement account that allows you to save money for the future, but the tax considerations work differently. With the Roth IRA, the money is taxed before it goes into the account. Then, the money is allowed to be invested while it is in the account. Any money that is earned from the investments is allowed to go into the account tax-free. Then when you reach the age of 59 1/2, you can withdraw the money tax-free. Therefore, all of the returns that you got over the years are yours to keep. 

Investing in Both

Many investors have started to put money into both types of accounts at the same time as a way to ensure that they will have enough money upon retirement to live comfortably. One thing to consider in this matter is the tax bracket that you are in. When you are younger, typically your tax bracket is going to be quite a bit lower than what it will be when you retire. Therefore, with a Roth IRA, you can actually pay quite a bit less in tax if you start funding it early on.

For example, you might pay only 15% tax on the money that is going into the account and then pay nothing on it later on. By comparison, if you use a traditional IRA, you are bypassing the 15% tax bracket that you are in now and possibly paying 35% tax when you withdraw. 

On the other hand, you never know how your investments are going to pan out. Therefore, using a traditional IRA allows you to save back more of your paycheck each month without incurring any taxes. Investing in both types of accounts allows you to protect yourself against investment risk and tax bracket considerations. 

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