When planning for your financial future, it’s important to understand the differences between the different types of retirement accounts you can consider. IRA stands for Individual Retirement Account, and there are two types of IRAs most commonly used. This article will help explain the difference between a Traditional IRA and a Roth IRA.
Both Traditional and Roth IRAs have eligibility requirements. A Traditional IRA is less restricted. As long as you are under 70.5 years old and have an earned income, you can contribute to a Traditional IRA. On the other hand, Roth IRAs do have some income restrictions. If you are a single tax filer, your modified adjusted gross income (AGI) has to be less than $132,000 in 2016 in order to contribute to a Roth IRA. If you are a married couple filing jointly, your AGI must be less than $194,000.
The reason most people choose either type of IRA is because they both offer attractive tax breaks. When it comes to taxes, though, the difference between Traditional and Roth IRAs is found in when you claim them. In a nutshell, traditional IRAs give you tax benefits when you put the money in. Roth IRAs help you when you take the money out.
When you contribute to your Traditional IRA, those deposits are tax deductible. You can write them off on your state and federal returns for the year the contributions were made. However, when you ultimately withdraw the money at retirement, it is subjected to standard income tax rates at the time.
Roth IRAs, on the other hand, come with no tax deductions for any contributions. All contributions are subject to income taxes when you deposit them into the account. You will actually see the tax benefits of a Roth IRA later as your earnings and withdrawals are typically tax-free.
Predicting the Future
No matter what, your IRA will be subject to taxation. It’s just a decision of whether you want to pay them now or later. It’s hard to know if the tax rates will be more or less now compared to when you plan to retire. For this reason, it’s important to talk with with your accountant and tax preparer at Ferguson, Timar & Company to make the right IRA decisions for your future.
Another significant difference between Traditional and Roth IRAs is when you can withdraw the savings. With a Traditional IRA, you are required to begin taking required minimum distributions (RMDs) when you turn 70.5 years old. Roth IRAs do not require this. If you want to hold onto the money or transfer that wealth to your heirs, you can keep it in the account and let it continue earning for you. When you turn age 59.5, you can begin taking penalty-free “qualified” distributions from either type of IRA. Before that, you will be subject to penalties.
There are other slight differences between Traditional IRAs and Roth IRAs that we’re happy to discuss, but the primary issues are outlined above. The information in this article is based on the 2016 tax year and current government regulations. Those can change and evolve with time, so make sure you are always up-to-date with your information before making any important financial decisions for your future.