If you’re planning to retire – in a few years or a couple of decades – you’ve no doubt heard of IRAs (individual retirement accounts) as opportunities to save money to help you cover your expenses after you’re no longer working. You may also know that there are two primary types: traditional and Roth. But before deciding which type to choose, you need to familiarize yourself with their key differentiating factors that will affect which one will work better for you.
Your age and your income may dictate your IRA type.
If you’re over the age of 70 ½, you can no longer contribute money to a traditional IRA, while a Roth IRA has no upper age limit – provided that you’re still receiving compensation from working.
Both types require that your annual earned income at least matches if not surpasses your contribution to your IRA. The one exemption is for nonworking spouses, who can contribute if they file taxes jointly.
However, a Roth IRA has limits on your annual contribution dependent on your income level. These limits vary based on your tax filing status and are subject to change on a regular basis. A traditional IRA has no such income-based contribution limitations.
Consider when you think you will want to start using your IRA funds.
If you have a traditional IRA, you have to begin taking required minimum distributions once you reach 70 ½ years old. Roth IRAs never require these.
Both will cost you a 10% tax penalty if you take a withdrawal before you are 59 ½. The traditional IRA tax penalty applies to withdrawn contributions, earnings or both, while a Roth IRA’s 10% tax applies only to earnings withdrawn early. You might also pay an additional 10% in taxes if your Roth IRA has not been open for at least five years, so plan accordingly.
The tax implications and benefits tied to each IRA type might also play a role in your decision.
Traditional IRAs are always tax-deferred, meaning you don’t pay taxes on your account’s earnings while they remain in your account. If you meet the established requirements, you might qualify for a deductible traditional IRA that allows you to subtract your contributions from your taxable income.
Roth IRAs don’t have this option. Your contributions come from your after-tax income no matter what. You reap tax breaks with this type of IRA post-retirement, when your withdrawals will, most likely, be tax-free.
Before investing in an IRA, go over your options with your financial advisor to ensure you’re making the right choice for your circumstances.
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