Summary: Saving for retirement is more important than ever, but deciding where to put savings can be perplexing. Learn the differences between IRAs and Roth IRAs.
Individual retirement accounts offer clients more benefits than just financial security. In addition to the long-term advantage of putting money away for retirement, there are tax benefits to both IRAs and Roth IRAs. Investors can also control which type of investments their accounts hold, including exchange-traded funds, stocks, bonds, mutual funds, and target retirement funds. Though both an IRA and a Roth IRA are similar in these ways, there are some key differences to consider before making a decision.
Tax Timelines of IRAs
The first thing to understand when comparing IRAs and Roth IRAs is that the tax breaks come into play at different times. Traditional IRA contributions are deduction-eligible on both state and federal returns during the year in which the contributions are made. Withdrawals of retirement income made during retirement are taxed at normal rates. Contributions to traditional IRAs also have the added benefit of lowering taxable income in the given year. Roth IRAs, on the other hand, do not lower taxable income in a given year, but withdrawals during retirement are typically tax-free, which could act as a big motivator in choosing this type of account.
IRAs and Future Tax Rates
No one can predict the future, which is why retirement planning is so important. Still, educated guesses can be made when it comes to future U.S. tax rates. This is an important aspect of investing to consider, given that income situations may fluctuate and that could ultimately affect the quality of a savings plan. If the tax rate on Roth IRA contributions right now is higher than the rate investors could pay on traditional IRA contributions down the road, then it may make more sense to choose a traditional IRA. The same is true for the opposite situation. Having as accurate a picture of the future as possible is vital to deciding between an IRA and a Roth IRA.
Withdrawal Rules of IRAs
Traditional IRAs dictate that required minimum distributions must begin at the age of 70 and a half. Roth IRAs do not require any withdrawals during a person's lifetime. This often makes Roth IRAs ideal for distribution of wealth to heirs. Traditional IRAs also come with a 10% penalty for withdrawing before age 59 and a half, and the withdrawal is taxed. Roth IRA contributions—not earnings—can be withdrawn penalty- and tax-free, even before the age minimum of traditional IRAs.
Anthony Petsis & Associates, Inc. was founded to assist our clients with financial planning for major events and financial decisions, including saving for retirement. Our experienced professionals have a hands-on approach, and we can help you determine whether you would benefit most from a traditional IRA vs. Roth IRA. Contact us at (215) 968-6638 today.