Traditional IRA vs. Roth IRA

Published on January 23, 2014

Uh oh – we’re in the fourth quarter of the calendar year, it will soon be time to send your tax documents to your accountant . . . and you didn’t set up an IRA yet to start saving for retirement?

No worries – you have until April 15, 2014 to make a contribution that will apply to the 2013 tax year. But now—well, any time—is ripe for opening up an IRA, if you don’t have an employer-sponsored retirement plan through work. Whether or not to select a traditional IRA or Roth IRA is the question. There are benefits to each type of retirement plan depending on the investor’s goals and situation. There are also certain restrictions around income, age, and other factors. Either one of these may be self-directed. We always recommend that our client consult their financial planner or tax professional about which type of retirement plan is best for their unique situation.

Traditional IRA 101

The traditional IRA (individual retirement account) was created in 1975 by the federal government for those Americans who did not have pension plans through their employers, and because (even back then), Social Security was not providing enough income during retirement. Sound familiar?

The IRA education page of our website lays out the basic information about traditional IRAs; for example:

• The traditional IRA is an account that is used to save pre-tax dollars for use in retirement.

• The contributions made to this account are tax-deductible.

• The minimum age that account holders are allowed to start withdrawing money is 59½; withdrawals made prior to age 59½ are subject to an early withdrawal penalty in addition to taxes owed.

• Account holders must start withdrawing funds, which are taxed as ordinary income, after reaching the age of 70½.

• Money grows tax free while it is in the account. Taxes are only paid once money is withdrawn.

• You may not be able to deduct all of your contributions if you or your spouse is covered by an employer retirement plan.

• You may set up a traditional IRA and make contributions if you (or, if you file a joint tax return with your spouse) received taxable compensation during the year, and you are under the age of 70½.

 With a self-directed IRA, whether traditional or Roth, SEP or SIMPLE (for employers and the self-employed) individuals may invest in a broad range of assets, not only stocks, bonds and mutual funds but the many alternative investments allowed within a self-directed retirement plan. If you have any questions about these assets or the types of plans that are available, please contact us.

 Roth IRA 101

The Roth IRA was created in 1997 due to the Taxpayer Relief Act. A big difference (there are a few) is that the funds you contribute to this type of retirement account are already taxed, so the money generated by the investments in a Roth IRA is withdrawn tax-free.

A Roth IRA is similar to a savings account. Money is invested to generate a sizeable profit. The profit you make will then be reinvested into a Roth IRA until the maturity date hits. A Roth IRA allows a person to withdraw funds tax-free and you aren’t required to ever withdraw the funds. The reason the money is tax-free is because the money is invested after you pay your taxes.

Here is some basic knowledge that you need to know about a Roth IRA which was covered in a previous blog post.

 Basic Information About a Roth IRA:

• When money is taken out of the Roth IRA, however, funds up to the amount put into it are always federal-tax free, and often the entirety of the funds are free from federal taxes.

• Intended for the middle class to help save for retirement. The basic uses include: purchasing a primary residence, medical expenses, and help fund a child’s college education.

• No penalties if you withdraw after a 5-year waiting period.

• Money invested is already taxed so any return you earn won’t be taxed if you wait to withdraw until you are 59½.

• No required age to withdraw from the account, and your beneficiary can inherit the account.

There are also restrictions towards a Roth IRA. When this was setup it was intended to help the middle-class. Therefore a single person who makes a gross income of $110,000 or more, and a married couple who earns an income of $160,000 or more is not eligible to contribute to a Roth IRA.

There are advantages and disadvantages to both types of IRAs. Now that you are educated about what a Traditional IRA and Roth IRA are we hope that you decide which one would be more beneficial to you when planning for your retirement. If you have any questions please don’t hesitate to contact one of our representatives at (888) 857-8058 or email us at Info@NextGenerationTrust.com.

For further information about Traditional IRAs and Roth IRAs please read up on information at https://www.irs.gov/