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Roth vs. Traditional IRA
When it comes to saving for retirement, you have quite a few options available. Whether it’s an employer-sponsored 401(k), traditional IRA, self-employed 401(k) or Roth IRA (or just Social Security for those who didn’t save in advance), deciding on the best account to save for your golden years may seem like a daunting task. In the realm of IRAs however, it’s relatively straightforward with two main options (traditional and Roth) and enough differences between them to see a clear brightline between the two.
If you’re going with the IRA route, which one works best for you? While there may be some big exclusions from Roth IRAs upfront (such as income levels and the existence of an employer-sponsored retirement plan), there are other factors to consider when opening an IRA. In this article I’ll discuss the differences and possible advantages and disadvantages of Roth vs. Traditional IRA choices.
In terms of age, traditional IRAs are stricter, with mandatory distribution age mandates saying that you may start withdrawing at age 59 ½ and you must start withdrawing by age 70 ½. There are also penalties involved for those who do not take out the required minimum distribution per year. And, if you withdraw too early, you’ll incur a 10% penalty (see the IRS’s six exemptions to this rule.)
Don’t let these restrictions deter you, however. There are numerous benefits to be reaped when you have a traditional IRA. For one, there are no income restrictions, thus everyone qualifies for this type of account. Furthermore, contributions are deductible. So if you contribute $3,600 in a give year, you may deduct $3,600 from your taxable income.
As for taxes on the account’s funds, they are taxed as a part of your regular income when you withdraw after age 59 ½. This is what makes traditional IRAs especially favorable to those in higher tax brackets in status quo: not only do you get a write off, but later on down the road—assuming you’ll experience a drop in income in your retirement years—you’ll be able to withdraw funds at a lower tax bracket than the one you have now.
The variety of investments you can make with a traditional IRA is another major advantage to this account: whether you want stocks, bonds, mutual funds, certificates of deposit, etc., you have greater flexibility with a traditional IRA.
While contributions to Roth IRAs are not tax-deductible and it’s only available to single-filers earning up to $110,000 or joint filers earning a maximum of $173,000 annually, there are still several advantages to opening a Roth IRA account.
Age? Not an issue. Withdraw early without penalties (so long as it’s principle funds and not earnings). Or, if you choose to wait, withdraw whenever you want, even if you wait past age 70 ½ (at which point, you’d be getting penalized for not withdrawing from a traditional IRA). Plus, if you follow the rules, earnings and principle are tax-free. What this means is that you won’t incur taxes on withdrawals from the account in the future because you didn’t get to claim tax write offs on original contributions to the account.
Essentially, your tax bracket in the future doesn’t matter as much with a Roth IRA because $5,000 deposited ten years ago will still be $5,000 when it comes time to withdraw (plus whatever earnings your investments made over the course of time).
Opening an Account
You can open an IRA at either a bank or a brokerage. Some banks and brokerages require a minimal account opening fee, but beyond that, it comes down to a matter of personal preference as to which path you want to take with your IRA. If you want more diversified investments in vehicles like stocks, options and bonds, perhaps it would be wise to open an account with a brokerage, since they are more uniquely suited to handle such investments. Or, if you prefer mostly mutual funds, Vanguard and Fidelity are the top two players in the mutual funds sector of the investment world. If you’re not sure what you’re looking for in your IRA investment-wise, perhaps start at a bank, where they can help you get started without hassle.
When it comes down to the question of “IRA: Roth vs. Traditional?” the decision is a matter of personal wants and needs. If you make over the income limit, obviously Roth IRAs will be out of the question, but otherwise, the decision process will take some time and calculation to determine what your projected income will be in the future. If you’re in a lower tax bracket than you are now, going with a traditional IRA would be a good idea. Inversely, if tax brackets don’t matter or you’d like to be able to withdraw tax-free in the future (and have no age limitations attached to the account), a Roth IRA would be a better choice.