Investing for your retirement is one of the most important things you can do for your future. Taking advantage of an IRA (Individual Retirement Account) to help supplement your future retirement income is always a good idea. Which IRA is best for you?
Before you open an IRA, take a look at the Roth IRA and the traditional IRA to see which one will benefit you more.
- Age – you must be under the age of 70½ by the end of the calendar year
- Income – to participate you must earn income (there is no maximum income limits)
- Contributions – may be tax-deductible, depending on income level
- Distributions – are penalty free and taxed as ordinary income when taken after age 59½
- Required Minimum Distributions – Are required April 1 of the year after the year you turn 70½
The advantages of a traditional IRA primarily deal with taxes. The tax savings at the time of the investment may be enough to decrease your taxable income to a lower tax bracket. Many retiree’s income is lower in retirement years, thus they may have a lower tax rate when they withdraw their funds.
The main disadvantage of a traditional IRA is the minimum required distribution. It requires IRA holders to withdraw a certain portion of their funds, whether they want to or not. It is also difficult to determine what your tax rate will be in retirement.
- Age – there are no age limits
- Income – to participate you must not exceed the income limits for that year
- Contributions – are not tax-deductible
- Distributions – are free from federal income tax when: the Roth IRA account has been open for at least 5 years, and you are age 59½ or older
- Required Minimum Distributions – are never required
The biggest advantage of a Roth IRA is the tax-free withdrawals on all the earnings. Another advantage is the absence of minimum withdrawal requirements. If you don’t need the extra income from the Roth IRA you can leave the money alone and let it continue to grow.
There are two big disadvantage to a Roth IRA. First, not everyone qualifies due to the income limits. And second, taxes are paid upfront.
So which is better for your own situation? If you are currently funding a company 401k plan or other tax deferred retirement plan, opening a Roth IRA may be the way to go. That way you can still decrease your taxable income through the 401k contributions, while growing money tax-free through Roth IRA contributions. It is difficult if not impossible to predict the future tax brackets, so tax diversification is a strong benefit to retirement planning. By having a combination of taxable and tax-free income during your retirement years will allow you to adjust your deductions to fit the tax brackets at that time.
Take a look at your personal situation and invest in whichever plan is best for you. If you are eligible for both, you also have the option of splitting your investment to take advantage of tax benefits now, and in retirement.