Roth or Traditional: Which IRA Is Right for You?
Filed under: Retirement
Maybe you already contribute to your employer’s 401(k) plan. If you’re ready to ramp up your retirement savings, however, you may also want to consider an individual retirement account, also known as an IRA. You can contribute as much as $5,500 in 2017 to either a traditional IRA or a Roth IRA. That limit increases to $6,500 if you’re age 50 or older.1
For many, though, the choice between a traditional IRA and a Roth isn’t an easy one. They both offer their own unique benefits. Which one is right for you? There’s no universal answer to that question. Your IRA choice should be based on your unique goals, needs and concerns.
Below is an overview of the key differences between the traditional IRA and Roth IRA in a few important areas. Consistent, disciplined saving in an IRA could make all the difference in having a financially stable retirement.
Taxes
Perhaps the biggest difference between traditional IRAs and Roth IRAs is how they are taxed. In both accounts, your investment growth is tax-deferred, meaning you don’t pay taxes on growth while the funds are in the plan. The difference lies in the tax treatment of your contributions and withdrawals.
In a traditional IRA, your contributions may be tax-deductible depending on your income and your access to an employer plan. Withdrawals from a traditional IRA are taxed as ordinary income.
Contributions to Roth IRAs are made with after-tax money and are not deductible. However, withdrawals from a Roth after age 59½ are tax-free. Traditional IRAs provide the tax break today, while Roth IRAs provide tax benefits in the future.
Income Limitations
As mentioned, your ability to deduct your traditional IRA contributions depends on your income level. If you’re a high earner, you may not be able to deduct the money you put into the account. You can always contribute to a traditional IRA no matter how much money you make. However, some or all of your contributions may not be deductible.
With Roth IRAs, you may not be able to contribute at all based on your income level. High earners are generally unable to contribute to Roths. If you don’t meet the Roth income limits, you could possibly contribute to a traditional IRA and then convert it to a Roth later.
Early Distributions
IRAs and other qualified plans are tax-deferred because they are intended for retirement savings. That means you generally aren’t able to take withdrawals from the accounts before age 59½. Any distributions before that age usually trigger a 10 percent early withdrawal penalty.
However, the Roth IRA offers some flexibility with early withdrawals. You can always withdraw your Roth IRA contributions without facing taxes or penalties, regardless of age. Your contributions are made with after-tax dollars. Since they haven’t received special tax treatment, they aren’t subject to penalty.
Required Minimum Distributions
Since traditional IRA distributions are taxable, the IRS doesn’t allow you to keep funds in the account indefinitely. At some point, you have to withdraw money and pay taxes on the funds. The IRS has set that point at age 70½, which is when you’re required to take minimum distributions from your traditional IRA.
Required minimum distributions, known as RMDs, are based on your account balance and your age. As you get older, you can expect the minimum withdrawal rate to increase. If you live deep into your 90s, you could be required to withdraw a substantial portion of the account every year.
Roth IRAs don’t have RMDs. You can keep your funds in the account as long as you’d like. In fact, you can hold funds in a Roth until your death without ever taking a withdrawal.
Estate Impact
There’s also a big distinction between traditional IRAs and Roth IRAs when it comes to estate planning. Generally, death benefit distributions from traditional IRAs are taxable.
There are exceptions to this. For example, a spousal beneficiary could simply assume ownership of the account and avoid taxable distributions. Beneficiaries can also spread out the distributions to limit the impact of taxes. However, all traditional IRA distributions are taxable at some point.
Death benefit distributions from a Roth IRA are tax-free. That means you can hold funds inside a Roth and then pass them on to your beneficiaries without creating a taxable event. Keep in mind, though, that if you fail to list beneficiaries or if your beneficiaries are deceased, the funds will go to your estate. That would create a taxable distribution and negate the tax benefits of the Roth.
Ready to start saving in an IRA? Let’s talk about it. Contact us at Ambrose Financial & Insurance Services today. We can help you analyze your needs and develop a strategy. Let’s connect soon and start the conversation.
1https://www.fool.com/retirement/2016/12/22/ira-contribution-limits-in-2017.aspx
Licensed Insurance Professional. This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
16831 – 2017/7/17
