Individual Retirement Accounts are trustee-based holding accounts that allow you to set aside a portion of your earned income toward your retirement years. There are two primary types of Individual Retirement Accounts; traditional IRAs and Roth IRAs. Both types of accounts have significant differences, but they also have some similarities. Both types of Individual Retirement Accounts permit you to invest in a wide variety of securities, including trading stocks.
You can fund your traditional Individual Retirement Account with pretax dollars. This means you can deduct the amount of your contributions to your traditional IRA from your income when you file your federal income-tax return. You must hold your traditional IRA through a trustee, which is typically a financial institution such as a bank, mutual fund or stock brokerage fund. You may invest the funds in your traditional IRA in stocks and you may trade stocks in your traditional IRA as often as you wish, within the parameters established by your trustee.
Traditional IRA Tax Consequences
There are no tax consequences for trading stocks within your traditional Individual Retirement Account, but you will be liable for any transaction fees and commissions resulting from such trading activity. All investments inside a traditional IRA are allowed to grow tax-deferred, regardless of how the growth occurs. Any capital gains that result from trading stocks in your traditional IRA are treated the same as interest or dividend payments, that is, they do not incur a current tax liability. You will pay taxes on all of your funds as you withdraw them from your traditional IRA. All withdrawals are taxed as ordinary income at your then current tax rate.
You can only fund your Roth Individual Retirement Account with after-tax dollars. Since you have already paid taxes on these contributions you can withdraw them at any time without causing a taxable event. As with a traditional IRA, you must hold your Roth through a trustee. You may invest the funds in your Roth IRA in stocks and you may trade stocks in your traditional IRA as often as you wish, within the parameters established by your trustee.
Roth IRA Tax Consequences
Stock trades within your Roth Individual Retirement Account do not result in a taxable event. You can trade stocks in your Roth IRA as often as you like, within the parameters set by your trustee. The growth of all investments inside your Roth IRA are tax-deferred until the earnings portion of your account is withdrawn. You will be liable for any transaction fees and commissions resulting from trading stocks, but not capital gains. You must leave any earnings in your Roth IRA for at least five years to qualify for tax free withdrawal. You can start taking qualified withdrawals once you reach age 59 1/2. If you withdraw your earnings early they will be taxed as ordinary income and you will be subject to a 10 percent tax penalty.
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