What is an IRA? Traditional vs. Roth

Way back in 1974, Congress passed a bill that created the Individual Retirement Account. The idea was to allow people who didn’t have a pension plan to set aside money for their own retirement. In 1981, the law was expanded to include everyone.

A cynic would say that the rise of the IRA (along with the 401(k) and similar programs) created a situation where employers could stop offering pension plans to workers. We’re just jaded enough to believe that, but we are determined not to be the sort of grumpy retired guy who complains endlessly about the government.

Given that, we try to take an objective and non-jaded view of IRAs.

And the objective and non-jaded view is that an IRA is a bucket. It’s a bucket where you can keep investments. It’s a pretty big bucket, and it will hold lots of different investments. You can put stocks in there. You can put bonds in there too. Heck, there are loads of things you can put in there.

But it’s not a bucket of infinite size. The government will only allow you to put a certain amount into your bucket -- and they base that amount on your age. People older than 50 can put away more than younger people.

Tool: IRA Calculator

The government also limits the types of investments you can hold in your bucket. Life insurance is wonderful, but you can’t hold it in an IRA. Avid stamp collectors, coin collectors, art collectors, antique collectors and drunkards will find that they cannot keep their beloved holdings in an IRA.

But the most important thing about the bucket is when the IRS will drink from it.

In a traditional IRA, the government promises not to take anything from your bucket until you do. The idea is that the investments in your bucket will grow tax free. But when you start pulling money out of your bucket, the government will start collecting taxes from it too.

In a Roth IRA, the government takes its share before you put your money in the bucket. Once you’re ready to retire, whatever is left is all yours. The government promises not to tax you a second time.

If you're willing to trust the government to keep its we-won't-tax-you-twice promise -- even as government deficits and spending continue to grow in future years -- then you should speak with an accountant about a Roth IRA.

 

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