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A traditional IRA uses pre-tax, or tax-sheltered money. This means that before taxes are taken out of your paycheck, money is put into your retirement account. A Roth IRA uses after-tax money, which you put into your account after you receive your paycheck.
Both types of Individual Retirement Accounts earn interest on their own or by placing them into other securities such as mutual funds, bonds or stocks. You can contribute $5,000 per month to both the traditional and Roth IRA if you are under 50 and $6,000 per year if you are over 50.
When you are ready to cash in your retirement accounts is when it gets tricky. When you cash in a traditional IRA, all the tax-sheltered money that has grown will be taxed at the new lump sum. When you cash in a Roth IRA, you get your money tax-free because it was already taxed before you put it in after receiving your paycheck.
It will all depend on what tax bracket you are in and how much you will earn in your IRA over time. Younger investors should definitely take a Roth IRA because they will be investing for a longer time.
Internal Revenue Service - Individual Retirement Accounts
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