Retirement planning education can cover a large variety of topics such as Individual Retirement Accounts (IRAs), Self Employment Plans (SEPs), Roth IRAs and IRA rollovers just to name a few.
Deciding on which investment vehicle is better for you overall can be a daunting task. Below we’ll compare the Traditional and Roth IRAs since these are two investment options that often confuse a lot of people.
Investing in the wrong type of IRA could potentially have large financial consequences but it’s important to note that it’s better to choose one than not to invest at all. Both IRA profiles are excellent ways to save for your retirement, although each offers distinct and different advantages.
Description
Both are savings plans created by the government that offer certain tax advantages for individuals who are willing to set aside money for retirement. In a Traditional IRA your contributions are made with pre-tax dollars and under the Roth IRA profile your contributions are made with after-tax dollars.
Tax Advantages
Under the Traditional IRA your investment grows with all of the taxes deferred until you begin to withdraw funds. Under a Roth IRA your account balances are allowed to compound tax deferred and the funds are withdrawn tax-free if the account is at least 5 years old and the owner is over the age 59 ½.
Eligibility
Under the Traditional IRA the participant must be under the age of 70 ½ and have earned income. With the Roth IRA your adjusted gross income cannot exceed $120,000 for single individuals and $176,00 for married couple. These amounts change frequently so its best to verify the income limitations the year in which you decide to invest.
Tax Deductions on Contributions
A Traditional IRA allows the participant to deduct their contributions from their income but a Roth IRA does not.
Penalty for Early Withdrawal
Both the Traditional and Roth IRA profiles impose a 10% penalty on withdrawals made before the age 59 ½. However, the 10% penalty on the Roth IRA is only on the earnings and not the principal.
Required Distributions
The Traditional IRA mandates that you begin making minimum withdrawals from the account after the age of 70 ½ but there are no required distributions imposed on the Roth IRA participant.
The difference between a Roth and Traditional IRA are just a few nuances and which one you choose depends on your individual situation. Most of the time the Roth IRA will be your best choice providing you within the income limitations.