There are two types of IRAs that individuals can create themselves, with extremely different characteristics. One is a regular IRA, for which the contributions are deductible.

A regular IRA will put you ahead if you’re in a high tax bracket when you make the contributions and expect to be in a lower bracket when you retire and take the distributions. For instance, if you are single and your taxable income is greater than $183,250, this contribution of up to $5,500 isn’t taxed at 33%. Assuming you take the distribution after you’re 59 1/2 years old and withdraw this $5,500 when your taxable income is less than $36,250 you are only taxed at 15%. This yields a tax savings of 18%, or $990.

The other type of an IRA is a Roth. With a Roth IRA, you can contribute up to $5,500 per year after tax. After you reach 59.5, you can withdraw any amounts you wish tax free. This is advantageous if you, or your spouse, will have significant pension, investment or other types of income when you retire. The contributed amount and all the gains are tax free. I may be pessimistic, but I think that by the time I reach 59.5 the government will have raised tax rates to pay down the deficit. A Roth IRA will protect people from this scenario. It is also a useful retirement vehicle if you are in the 15% tax bracket, as I can’t envision taxes for a single person making over $15,000 a year ever getting below this tax rate.

Another reason that I am fond of a Roth IRA is that it isn’t subject to the same harsh early distribution penalties as a regular IRA. With a regular IRA, if somebody ever becomes destitute or needs money for emergencies they will be penalized 10%! (There are exceptions for medical insurance premiums for the unemployed, qualified higher education expenses and up to $10,000 for a first time home purchase).

This takes away the whole tax savings of a regular IRA as outlined above. I for one don’t like the idea of the government having a certain level of control over when I can take out my money. On the other hand a Roth IRA’s early distributions are only penalized above the contributed amounts. This means that the 10% penalty will only kick in after all the contributions are withdrawn first, the earnings are the only portion that could be penalized. So if I put in $50,000 over 10 years and that money has grown to $100,000, I could take out the $50,000 of contributions with no penalty and no tax. This I like as it gives me more control over my money in addition to not worrying about unknown future tax rates.

Another rule to keep in mind is that contributions can only be made if the taxpayer makes under a certain amount. For a Roth IRA, the $5,500 contribution limit is $110,000 in adjusted gross income for single people and $173,000 for married couples. For a regular IRA, and for active participants in an employer retirement plan, the contribution limit is $59,000 for single people and $95,000 for married people. People not involved in an employee retirement plan have no income limit in order to contribute to a regular IRA. So, especially if you’re invested in a 401k at work which has the same withdrawal characteristics as a regular IRA, put some money into a Roth IRA!