What's the difference between a savings account and a Roth IRA?

Retirement Savings, IRAs
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April 2017
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There are a host of differences between a savings account and a Roth IRA.

First, a savings account is typically offered through a bank. As a bank deposit, these funds are guaranteed by depositor insurance in case the financial institution were to fail. Because these accounts have little risk, you are paid an interest rate that reflects this. You'll find savings account interest rates hover near 0%. You'll also receive a Form 1099-INT from the bank annually (assuming you earn at least $10 per year in interest) that will also be reported to the IRS. You'll have to include this interest income on your tax return which will become part of your taxable income. Savings accounts are great vehicles to build up money that you can access for emergencies or unexpected expenses.

A Roth IRA is a retirement account. You can set these up through a bank, brokerage firm, mutual fund company, or an investment management account through a Registered Investment Advisor.

With a Roth IRA, you'll have access to a variety of investments beyond just a money market account, which is the closest approximation with a bank savings account. You may invest in stocks, bonds, mutual funds, unit investment trusts, master limited partnerships, and more. You have a greater potential for gain and accordingly have more risk and exposure to volatility in returns.

Unlike a savings account, you do not need to pay taxes on earnings (dividends, interest or capital appreciation) each year. And in retirement, you do not pay income on these earnings either. Why? Because you don't take a tax deduction for contributions to a Roth, you are investing "after-tax" money" so you don't pay taxes on the gains later when you make withdrawals in retirement.

Another feature of a Roth IRA is that you don't have to take distributions in retirement. Unlike a traditional IRA or your 401(k) plan at work, you are not required to take any distributions. You could, in effect, choose to let the money compound through retirement and then potentially leave a bigger pie as a legacy for your beneficiaries who inherit the funds.

Unlike a savings account, there are limits on how much you can contribute each year based on your age and adjusted gross income.

One great feature of a Roth IRA is that you can access your principal (what you contributed from time to time) without a tax penalty for early withdrawals. There are exceptions that allow investors to access the funds to help pay for college or a first-time home purchase. This is why these are great savings vehicles by parents of college-bound students or by students themselves. Unlike a 529 savings plan which requires the funds to be used for qualified education expenses, a Roth IRA can be used for other things allowing more flexibility. So a parent wouldn't have to tie up funds in a 529 for a student who might not use the funds because he chose not to go to college or trade school, or received a scholarship and didn't need the 529 funds.

April 2017
April 2017
April 2017
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