Differences Between a Roth IRA and a Traditional IRA

When it comes to preparing for your future, one of the more important things you need to do is invest for your retirement. A great way to do this is to open an IRA (Individual Retirement Account). When it comes to contributing into an IRA there are two main types you may be eligible for- the Roth IRA and Traditional IRA. Which one is the best?

Traditional IRA
The Traditional IRA can be simply defined as a retirement vehicle that is tax deferred. Traditional IRA plan contributions can be tax deductible. It depends on what the taxpayer’s income is as well as tax filing status among other factors. Traditional IRA contributions are pre-tax, which means contributions are made with money that hasn’t been taxed.

The main benefit of investing pre-tax dollars is there is the potential for lowering the current tax bracket that you are in. Your money continues to grow on a tax free basis until you are ready to withdraw the funds. Qualified withdrawals are then considered ordinary income and can be subject to income taxation.

Income Limits: Anyone can contribute to Traditional IRAs. However, everyone will not receive a tax deduction benefit. There are deductibility limits to Traditional IRAs.

Withdrawals: Holders of a Traditional IRA are eligible for making IRA withdrawals at the age of 59 ½. The withdrawals are then taxed just like other forms of ordinary income. Early withdrawals, with a few exceptions, are subject to stiff penalties.

Required Minimum Distributions: Traditional IRA owners must start to make Required Minimum Distributions when they turn 70 ½. Every year holders of a Traditional IRA must make minimum withdrawals whether they need that money or not.

Traditional IRA Advantages: They are several key advantages to investing in Traditional IRAs. They are primarily tax advantages. At the time you invest in a Traditional IRA the tax savings may lower your taxable income and result in a tax bracket that is lower. Also, many people after they retire are in lower tax bracket than during their working years. Therefore when funds are withdrawn they may be taxed at a lower tax rate. Depending on what your income level is, investing in a Traditional IRA may place you in a lower tax bracket while you are working. Then after you retire and withdraw your money you may be taxed at a lower rate because your income level is lower.

Traditional IRA Disadvantages: The main disadvantage to a Traditional IRA is its minimum required distribution. It requires that an IRA owner make withdrawals- whether they need the money or not. Also, it isn’t easy determining what your retirement tax rate is going to be.

Roth IRA
A Roth IRA, simply defined, is a retirement vehicle that is tax exempt. Roth IRA contributions when made aren’t tax deductible. However a qualified distribution that is made in retirement is not subject to tax.

Income Limits: Individuals with the tax status of Single can’t earn more than $95,000 and for Married $150,000 is the maximum annual income level.

Withdrawals: the minimum age for withdrawals is 59 ½. At the time money is withdrawn it is not taxed. Also, withdrawals on the principal can be done without penalty at any time. If earnings are withdrawn early, however, they are subject to penalties and taxes.

Required Minimum Distributions: Roth IRA accounts have no minimum distribution requirements.

Roth IRA Advantages: Tax free withdrawals on earnings and principal is the biggest advantage for Roth IRAs. Not having minimum withdrawal requirements is another important advantage.

Roth IRA Disadvantages: The income limits mean not everyone will qualify to invest in a Roth IRA.

Traditional or Roth- Which IRA is the Best?
Investing in an IRA is a great way of diversifying your taxes for your retirement years. Both types of IRAs have distinctive advantages. If you have an option for investing in your employer’s 401(k) or other types of retirement plan that is tax deferred, you may want to choose a Roth IRA. That way you have investments that give you a current benefit through decreasing your taxable income through the 401(k) contributions and also having a Roth IRA investment to provide you with tax free withdrawals after you retire. It’s every hard, and sometimes impossible, predicting what our tax brackets will be in the future. That’s why tax diversification is such an important benefit when it comes to retirement planning.

You should thoroughly investigate your personal situation before investing in any plan. That way you can determine which type of IRA is best for you and your situation. If you meet the eligibility requirements for both types, you can split your investment, therefore taking advantages of tax benefits both now and after you retire.