In the 1970s, lawmakers realized many of us did not have company-sponsored pension plans. As a result, Congress created individual retirement accounts, or IRAs, to help people plan for their retirement. IRAs come in two types. The first is a tax-deferred IRA, in which you don't have to pay the taxes until you begin withdrawing the money when you retire. The second is a Roth IRA, in which you pay the taxes now when rates are lower, not later when taxes are higher. In 2014, the most a person can contribute to either IRA was $5,500 -- $6,500 if you're 50 years or older [sources: IRS, USAA, Edward Jones].
The Roth IRA is special. Born in 1997, the Roth IRA isn't only a way to provide the middle class with a way to save for their retirement, but it also acts as a savings plan that allows people to use the money they contribute towards the purchase of a primary residence. They can also use the money to pay for medical expenses and for a child's education. If you have a traditional IRA, the contributions that you make each year are tax deductible. Contributions to a Roth IRA, however, are not tax deductible. But five years after opening a Roth account, you can start taking qualified distributions that are tax-free [sources: IRS, IRS, USAA, Edward Jones].
These tax-free distributions also kick in if/when you reach the age of 59.5 years old; or you have a disability; or if you're withdrawing to cover up to $10,000 of buying your first home. Also, if you withdraw your Roth IRA contributions to pay for your child's college, you won't get taxed or penalized. If your kids decided they don't want to go to college, or find some other way of paying for their education, you can keep the money in your Roth IRA instead of moving it to a different savings account [sources: IRS].
- Edward Jones. "Opportunity for Tax-Smart Investing in your Portfolio." (Oct. 10, 2014). https://www.edwardjones.com/en_US/needs/common_questions/lower_taxes/index.html
- Internal Revenue Service. "IRA Deductions." (Oct. 2014). http://www.irs.gov/Retirement-Plans/IRA-Deduction-Limits
- Internal Revenue Service. "Roth IRAs." (Oct. 10, 2014). http://www.irs.gov/Retirement-Plans/Roth-IRAs
- USAA. "IRA Spells Tax Savings—Now or Later." Jan. 1, 2014. (Oct. 10, 2014). https://www.usaa.com/inet/pages/advice-retirement-iraspellstaxsavings?akredirect=true