When deciding which type of retirement vehicle is right for your financial future, you have several options from which to choose. The most common question that most people face when considering individual retirement accounts (IRA) is which type of IRA is better. There are several forms of IRAs available but the biggest decision will be whether you opt for a Roth or traditional IRA. Before you can make the final decision, you must first consider all the factors. Each form of retirement account has its own unique benefits as well as drawbacks, making it important to learn as much as possible before you open your account. Here we look at both types, Roth and traditional, to see which IRA is right for your unique financial situation.
A Roth IRA is an excellent retirement vehicle for individuals who qualify for this type of account. There are income requirements which must be met in order to qualify as a contributor to a Roth IRA. You or your spouse may not contribute more money per year than you earn in qualified income and you may not go over the maximum amount with your modified adjusted gross income. These figures can change per year, therefore you should determine in advance if you qualify as a contributor before considering this type of account.
There are several differences between a Roth IRA and a traditional IRA. What most people consider the most significant difference in how each retirement account is taxed. A Roth IRA when managed correctly and with qualified distributions is the best way to avoid taxation on investments. This is due to the fact that contributions to the Roth IRA are not tax deductible, therefore you pay income tax on the amount of money you have contributed at the time you file your tax return. As a result if all rules regarding distributions are followed you will be able to withdraw that money without ever paying tax on contributions and earnings. A qualified distribution is as follows:
- occurs five tax years after the account has been opened
- account holder is 59 1/2 years of age
These rules apply to earnings only, contributions to the Roth IRA can be withdrawn at any time without taxes or penalties. Withdrawal of earnings that are not qualified distributions will in most cases result in taxation and penalties.
Another benefit of a Roth IRA is the fact that you are not required to withdrawal money by age 70 1/2. The money can remain in your account until the time of your death, when it would be distributed to any beneficiaries.
If you opt for a traditional IRA you do not have to worry about income restrictions and you will have immediate tax benefits in that contributions are tax deductible. In some financial situations this is ideal, however it is important to remember that sooner or later you will end up paying income tax on the any monies distributed from the account. If you withdrawal money prior to age 59 1/2 you will also face a 10% penalty fee unless your distribution falls within certain exceptions.
Both the traditional and Roth IRA are great examples of how to save money for retirement. It is important to consider all of the options available to you before making your final decision to ensure you are investing wisely in your future.
This article was written by Brandon Langston of RothIRA.com’s Retirement Planning Blog. Visit his site to learn more on the RothIRA.com investment product!