Nothing stays the same forever, including your ability to continue working for a living. At some point you will stop working, therefore, it is important to start making preparations for this inevitability by developing a comprehensive retirement plan.
One of the most common and effective strategies for planning for retirement is through the use of an individual retirement account (IRA). These are tax-advantaged retirement accounts that allow your contributions to accrue in value. There are two types of IRAs: traditional IRA and Roth IRA.
Basic differences between traditional and Roth IRAs
The traditional IRA was established in 1974 while the Roth IRA came later in 1997. The Roth IRA was named after Senator William Roth who was the sponsor of the law that created this type of IRA. The differences between these two types of IRAs lie in when tax deductions are available, how accessible your funds are, and eligibility standards.
Taxes on contributions and withdrawals
With a traditional IRA your contributions are deducted from your reported income and you delay paying tax on the income until the time of withdrawal. On the other hand, Roth IRA contributions are taxed as income immediately while withdrawals during retirement are tax-free.
Early withdrawal rules
Withdrawing your funds from a traditional IRA before you reach the official retirement age of 59½ will result in a 10% early withdrawal penalty charge. Alternatively, with a Roth IRA you can withdraw up to the amount you originally contributed to the fund at any time without incurring any penalties.
However, if you want to withdraw earnings from your Roth IRA beyond your contributions before 59½ you will be hit with a 10% charge. There are certain instances where you may be able to avoid this early withdrawal charge with your Roth IRA. Our professionals at Paramount Wealth will be able to explain these exemptions to see if they are the right move for you.
Traditional IRAs are subject to required minimum distribution (RMD) rules which require that you start withdrawing funds once you reach the age of 72. The amount is dictated by RMD regulations which our team can help you calculate. On the other hand, Roth IRAs do not have a minimum distribution requirement for the account holder. However, beneficiaries of both traditional IRAs and Roth IRAs will be subject to RMD rules.
Can I have both types of IRAs?
Having both types of IRAs is allowed, however this may not be advantageous for everybody. The financial professionals at Paramount Wealth can help you decide if having both types of IRAs is a good idea for you.
Which IRA type is best for you?
Whether a traditional IRA or a Roth IRA is an effective retirement strategy will depend on your income level and various other aspects of your personal financial situation. Our team will be able to analyze your current finances and help you decide which IRA type will work with your comprehensive retirement plan.
Any opinions are those of the author and not necessarily those of Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Raymond James and its advisors do not offer tax or legal advice. You should discuss any tax or legal matters with the appropriate professional.
Like Traditional IRAs, contribution limits apply to Roth IRAs. In addition, with a Roth IRA, your allowable contribution may be reduced or eliminated if your annual income exceeds certain limits. Contributions to a Roth IRA are never tax deductible, but if certain conditions are met, distributions will be completely income tax free.
RMD’s are generally subject to federal income tax and may be subject to state taxes. Consult your tax advisor to assess your situation.