What Are The Differences Between A Traditional IRA And Roth IRA?
There are many differences between a Traditional Individual Retirement Account (IRA) and a Roth IRA. Understanding the differences between the two types of retirement accounts can help you make the best decisions to maximize your retirement savings. There are many implications that factor into your decision such as tax minimization, availability of funds, mandatory withdraws, income limitations, and other factors that impact your retirement investments in a Roth or Traditional IRA.
The Main Differences Between A Traditional IRA And Roth IRA
When You Will Pay Your Taxes
The greatest benefit of a Roth IRA is that your earnings, capital gains, interest, and dividends grow and can be withdrawn tax free in retirement because a Roth IRA is funded with after-tax dollars. A Traditional IRA, on the other hand, is funded with pre-tax dollars that reduce your taxable income directly from your paycheck before you pay taxes. So, taxes are owed when you withdraw the funds from a Traditional IRA at your ordinary income tax rate. While this may not seem like a big deal on the surface, this can have dramatic impact to the amount of taxes you pay. Roth IRAs are very beneficial if you invest your money while in a lower tax bracket and subsequently withdraw it in your retirement years while in a higher income tax bracket.
Income Limits Who Can Contribute To Roth IRAs
Not everyone is eligible to contribute to a Roth IRA. There are income limits, and you must not earn more than a certain amount of money each year in order to contribute to a Roth IRA. For example, a married couple filing a joint tax return can only fully contribute to a Roth IRA if they earn less than $169,000 per year. You can continue to partially contribute to a Roth IRA until your income exceeds $179,000, and then you are completely ineligible for a Roth IRA. For single income tax filers, you can contribute to a Roth IRA as long as you do not make over $107,000, and the investment option of a Roth IRA is completely phased out for single tax filers who earn more than $122,000 in 2011. Traditional IRAs do not have these types of income limits.
Required Withdrawals In Retirement
Another of the fundamental differences between traditional and Roth IRA is when you are required to withdrawal funds from your IRA account. The Internal Revenue Service (IRS) requires investors to start taking mandatory distributions from a Traditional IRA when they reach the age of 70 ½. There are no such requirements for a Roth IRA. As long as the original owner is still alive, you can continue owning and investing in a Roth IRA. Your heirs have five years after your death to begin distributions of a Roth IRA.
There are many different aspects to the two retirement investment plans. There are many more differences that were not discussed fully in this article such as minimum distributions for Traditional IRA investors, passing IRAs to your heirs, and other differences. While Traditional and Roth IRAs share a lot of similarities, it is also important to understand their fundamental differences as well so you can choose the right investment for you and your family
Tom Fischer is a Financial Planner is Scottsdale Arizona helping to educate through sharing.