If you are looking to start an Individual Retirement Account you may be wondering where to start. The two main types of IRA accounts are Traditional and Roth. This article will explore the differences between the two types of IRAs so you can choose which works best for you.
Tax Benefits
- Traditional IRAs: You fund a Traditional IRA with pretax dollars or money you have not yet paid taxes on. You get the benefit of being able to deduct the amount you contribute from your taxes. However, the IRS limits you to $5,500 a year in contributions to all IRAs combined (both Roth and Traditional). How much of the $5,500 you can deduct is dependent on two factors. These factors are, your adjusted gross income and whether or not you have any employer-sponsored retirement plans available to you. You can find charts that outline these limits on the IRS’s website by clicking here. Also keep in mind that when you begin withdrawing you will have to pay taxes on those funds.
- Roth IRAs: Roth IRAs offer no upfront tax benefits. You only contribute after-tax dollars or money you already paid taxes on. Their major benefit is that since you already paid taxes on the money, your withdrawals during retirement will be tax-free.
Early Withdrawal Penalties
- Traditional IRAs: To take any withdrawals penalty free you must be over 59 1/2. You will have to pay your normal tax rate on any withdraws. You will also have to pay an additional 10% penalty from the IRS.
- Roth IRAs: If you choose to withdraw from the money you have contributed, you will not be subject to any penalties. However, if you are under 59 ½ and you withdraw from your earnings, you will have to pay taxes on it as well as a 10% penalty.
- Exceptions- Of course, there are some exceptions to the withdrawal rules. If you withdraw money for certain qualified distributions, you will be exempt from the 10% penalty. These qualified distributions include:
- First-Time Home Purchase: You can withdraw up to $10,000 penalty free, per spouse if the money is going towards buying, building, or rebuilding a first-time home.
- Higher Education: If you are paying for tuition, fees, books, or supplies for you, your spouse, your children, or your grandchildren, you can withdraw money penalty free to cover those expenses.
- Medical Expenses: If you have been unemployed for at least 12 weeks or you are under 59 ½ but considered disabled, you can take money out of your IRA penalty-free to pay for unreimbursed medical expenses and health insurance premiums.
- Inherited IRA: If you inherit an IRA you will not have to pay the 10% penalty on withdraws as long as you do not designate yourself as an account owner or roll the inherited IRA into your own IRA or another retirement plan.
Retirement Benefits
- Traditional IRAs: If you have a Traditional IRA you will be required to take minimum distributions each year, beginning the year you turn 70 1/2. At this time you will no longer be able to contribute any more money to your account.
- Roth IRAs: Roth IRAs do not have required minimum distributions. You also have no limit on how long you can contribute for. Even after you turn 70 ½ you can continue to put money into your account.
Conclusion
Every type of investment account has positive and negative attributes. By arming yourself with knowledge about IRA’s you will be able to weigh the differences and find which type of account works best for you. You may also find that both a Traditional IRA and a Roth IRA would be of benefit. If you have questions, want to learn more about IRAs, or are ready to set one up, click here to contact a Certified Financial Planner in your area who can be of assistance.