Preparing for retirement can be a challenge, especially because of the multiple ways that you can start saving. When it comes to selecting the best IRA, there are two options: traditional IRAs and Roth IRAs. Depending on your financial situation and retirement plan, either IRA can be a viable choice.
Before making a selection, the best way to make an informed decision is to compare the two side by side. What are the benefits? What are the drawbacks? Which is better suited for your lifestyle and pocketbook? As you debate between traditional and Roth IRAs, here are some comparisons you should know.
Income Allowances and Age Restrictions
When researching traditional and Roth IRAs, income allowances are a main point of comparison. Anyone can open a traditional IRA. Traditional IRAs allow anyone with earned income younger than 70 ½ to contribute funds. Additionally, tax-deductibility depends on income and whether your spouse has a retirement plan through their employer.
Roth IRAs, on the other hand, have income-eligibility restrictions. Single tax files must have a modified adjusted gross income of less than $137,000 to contribute. Married couples filing jointly need to have a modified AGI of less than $203,000.
The limits are phased out with modified AGI of $122,000 and $193,000, respectively as per IRS regulations. A plus to having a Roth IRA is that there are no age restrictions for contributions. You can continue to contribute for as long as you wish. Depending on how long you want to save and how much you make, either IRA can be right for you.
When it comes to tax incentives, traditional IRAs come out on top. Yearly contributions are tax deductible on both state and federal returns. These funds grow, tax-deferred until you reach retirement age. Once you start withdrawing from your account in retirement, the funds will be taxed according to ordinary income tax rates, and by age 59 ½, you may be part of a lower tax bracket. Depending on your yearly earnings, you can really benefit.
While there is no up-front tax break with Roth IRAs, these funds can benefit the owner after they hit retirement. All withdrawals from your Roth account following your retirement are tax-free. If you don’t want to worry about dealing with taxes in your golden years, this may be the best IRA for you.
Both traditional IRAs and Roth IRAs avoid taxes as they grow. This choice boils down to when you want to pay taxes on your contributions.
Account Withdrawal Rules
Another area where these two IRA accounts differ is when account holders need to start withdrawing funds. While traditional IRA owners can begin removing funds without penalty at 59 ½, they must start taking required minimum distributions or RMDs at age 70 ½. If they do not, they can be penalized for not taking the mandatory percentage.
Same as traditional IRAs, Roth IRA account holders can take funds penalty-free after 59 ½. The difference is that Roth IRA owners need to contribute to their account for at least five years. Other than that one rule, there are no required withdrawals for Roth IRAs. Your fund can continue to grow long-term with only upfront taxation. Also, it is possible to pass a Roth IRA to your family members. There is no limit to growth.
Bonus Comparison Tips
If you’re still having trouble weighing your options, here are a few other points to consider. Making contributions can lower taxable income for traditional IRA owners. If these account holders make yearly contributions, it is possible to lower taxable income. Additionally, traditional IRA owners can qualify for additional tax credits based on their spouse’s plan.
For Roth IRA owners, contributions – not earnings – can be withdrawn penalty or tax-free at any time. Also, Roth IRA owners can invest in anything: index funds, stocks, alternative investments, and more.
Either plan can receive the benefit of a penalty-free withdrawal of $10,000 as long as it meets certain requirements. Qualifiers include first-time homebuyers, those experiencing hardship due to unreimbursed medical expenses or disability, and account holders seeking higher education. Traditional IRA owners, however, would still be subject to taxes on the withdrawal.
Which will Work for you?
After considering the pros and cons of each IRA option, the best course of action is to see how your personal financials match up. If you are interested in tax-deferred growth and up-front tax-breaks, traditional IRAs may be the best choice for you.
If you have limited funds and prefer flexibility, a Roth IRA may be a better option for your budget. Consider long-term growth and how much you can contribute yearly. Before making any big decisions on your retirement plan, consult with your personal financial advisor and select the best option for your future. Take the leap and start saving your nest egg today.
Traditional IRA vs. Roth IRA: Comparison Chart of Positives
|Traditional IRAs||Roth IRAs|
|Contribute until age 70 ½||No Age Restriction|
|No income limitation||Income-eligibility limitations|
|Contributions are tax-deductible||No up-front tax break|
|Tax-deferred growth||Tax-free growth|
|RMD at age 70 ½||No RMD|
|Lower taxable income during contribution years||Required 5-year period before withdrawal|
|Can be invested in many different avenues|
|Contributions can be withdrawn without penalty|
|Can be passed down|