Most know and understand that they need to save for retirement. They know that they have to set aside money in an investment account that can potentially accumulate but there are so many options to retirement accounts. How do you choose which option will work best for your situation? Let’s start with the two major types of accounts and what each entails.
Before getting into the nitty gritty differences between the two types of accounts, why don’t we see if you’re eligible?
Your eligibility is determined by your income for each type of IRA account. The two types of account we will discuss today are Roth IRA accounts and traditional IRA accounts.
For a Roth account, you must earn less than $122,000 or if you are filing jointly, it is $193,000 to fully contribute.
For a traditional IRA account, there are not many eligibility restrictions and essentially, anyone can open one. There are limitations within the account which will be discussed later on.
One of the biggest differences between Roth and a traditional IRA is the timing on taxes. With a ROTH, your money is taxed prior to putting the money in the account and once the money is taken out of the account, it is tax free. With a traditional account, the funds are taxed upon withdrawal of the account. Basically what this means is, if you were to withdraw $100 from a traditional account, because of taxes, more than $100 will be taken out. If you do not pay attention to that, you could deplete your fund faster than you had planned. Planning accordingly is essential to making a traditional IRA work. There are benefits and drawbacks to both depending on your financial situation.
One great thing about Roth IRA accounts is that you can withdraw contributions early without being charged with income taxes or early withdrawal fees. While this is a benefit to this account, if you can, try not to withdraw from the account because the more you withdraw, the less you will have during retirement! The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax/ Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
With a traditional IRA account, there are hefty penalty fees for withdrawing funds. Although there are certain circumstances where you can withdraw without fees so check those out on the company offering the account’s site. It is strongly discouraged to withdraw funds early from a traditional account so think of your situation and ensure that you would not need this money before retirement.
Currently, both Roth IRAs and traditional IRAs have a contribution limit of $6,000 a year or if you are over 50 it is $7,000. You can have both types of accounts, however, your contributions cannot exceed the amount listed above.
Some other differences between the two accounts are that with a traditional IRA, you have the potential to deduct your contributions from your yearly earnings and be taxed at a lower level which is a great tax benefit. This is not the case with a Roth because you do not receive a tax benefit right away. You do receive the luxury of having your account grow and be withdrawn tax-free due to the fact that the money put into the account was taxed prior.
Having the tax break is fantastic for individuals who may not save for retirement otherwise or those who may be in a higher tax bracket. This option can potentially save you money in retirement depending on your situation but the one downfall is the burden of paying taxes once you withdraw the money so you will have to plan accordingly.
Roth IRAs are great because your contributions are taxed when they first go into the account which is great, however, you are investing less in the end. What does this mean? If you were to put $100 in a Roth and $100 in a traditional, your principal in the traditional is higher thus you are investing more each time because taxes are not taken out until after. There are many good things about Roths and are suitable for many individuals. Early withdrawals, fewer fees, and tax-free withdrawals are some of the major benefits of opening a Roth. It can be confusing and hard to decide which account will best suit your needs but doing research can help you decide!
Talk to a financial advisor to see which option (or combination) works best for you. Adam Hogue can help you decide on the best path to take.
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