IRA or Roth IRA for Your Retirement Plan?
April 26, 2010
IRA vs Roth IRA was the question for many people opening up a retirement account right before the tax deadline this month so I thought we’d re-visit it for people looking to make an ira contribution. Here are some of the major differences between a traditional IRA and a Roth IRA.
Tax Deferred Contributions vs Tax Exempt Earnings
With a traditional IRA contributions are tax-deferred, meaning that you don’t pay income taxes on the money you put in until you take the money out. With Roth IRA contributions on the other hand, you pay income taxes on the money you earn and put into the account but the earnings when you take money out are tax free.
IRA Minimum Distribution
Both the traditional IRA and Roth IRA require you to wait until 59 1/2 to start withdrawing your earnings without penalties. With the traditional IRA you have to start taking distributions at 70 1/2 years old but the Roth has no minimum distribution requirements. The government doesn’t really care when you take out your earnings for a Roth since they don’t see any tax revenue from it but with a traditional IRA they want to make sure you don’t delay your IRA distributions (and their tax revenue) too long.
One of the advantages of the traditional IRA is that you can reduce your taxable income during your working years. Since that income isn’t taxed right away, you have more to invest and the hopes are it will grow for the next several decades until you reach retirement age.
Of course the downside to the IRA is that you are hit with a big tax bill in retirement when you withdraw money from your account. If you anticipate being in a lower tax bracket when you retire than when in your working years then you would pay less taxes. Keep in mind that no one knows what the tax laws will look like decades from now.
One of biggest advantages of a Roth IRA is that you only pay tax on the contributions, the earnings are tax free. So if you invest your money wisely and it grows by leaps and bounds over the next several decades then you’ll have some nice IRA distributions that aren’t taxed.
Another benefit to a Roth IRA is that you can withdraw any principal you’ve paid in prior to retirement without a penalty. Since an IRA is an “Individual Retirement Account”, it’s best to save the money for retirement when you have have a working wage coming in. However, in an extreme circumstance it’s nice to know you could access the Roth IRA contributions if needed. This does not include the earnings, if you withdraw those early you will pay a penalty.
The obvious downside to a Roth IRA is that the money you contribute is not pre-tax so you don’t lower your income taxes in the year you put money in. Another potential issue with a Roth IRA is that it does have maximum income limitations so so high-income earners don’t have the option of opening one.
Opening an IRA
Deciding between a regular IRA and Roth IRA should not become a retirement investing roadblock. Don’t let indecision hold you back from getting started investing for your retirement years. Just because you open a Roth IRA this year and fund it doesn’t mean you can’t contribute to a traditional IRA instead next year. The most important thing is to get started putting some money away!
All posts by Ben Edwards