Friday, May 11, 2012

Roth IRA vs Traditional IRA

An IRA is an Individual Retirement Arrangement that provides tax advantages.  Generally, there are two types of IRAs to choose from, Roth IRA or Traditional IRA.
  • A Roth IRA is funded with “after-tax” money, or money that has already been subject to income tax.  The Roth IRA grows tax-free and withdrawals at retirement are usually tax-free.
  • A Traditional IRA is funded with “pre-tax” money, or money that has not been subject to income tax.  The Traditional IRA grows tax-free withdrawals at retirement are taxed as income.
There are several advantages/ disadvantages to both IRA types.  The main difference is getting the tax break now or when you retire.
Some reasons I Like the Roth IRA…
  • Direct contributions to a Roth IRA may be withdrawn tax free at any time.  (May not withdraw Traditional IRA contributions without incurring penalties)
  • Contributions may be made to a Roth IRA even if the owner participates in a qualified retirement plan such as a 401(k)  (Contributions may be made to a traditional IRA in this circumstance, but they may not be tax deductible.)
  • The Roth IRA does not require distributions based on age.  (All other tax-deferred retirement plans require withdrawals to begin after the owner reaches age 70½)  (Great way to leave money to your heirs)
Some reasons I Don’t Like the Roth IRA…
  • Contributes to a traditional IRA instead of a Roth IRA get an immediate tax savings.
  • A taxpayer who pays state income taxes and who contributes to a Roth IRA will have to pay state income taxes on the amount contributed.  However, if the taxpayer retires to a state with no income taxes, then the taxpayer will avoid paying state income taxes altogether by instead contributing to a traditional IRA.
  • The perceived tax benefit may never be realized with a Roth IRA.  Early death or a short retirement period may reduce the full benefit.  One must live until one’s Roth IRA contributions have been withdrawn and exhausted to fully realize the tax benefit.
  • Congress may change the rules that currently allow for tax free withdrawal of Roth IRA contributions.
Hopefully this helps simplify the complicated world of IRAs.  A great, easy to read, chart can be found on Wikipedia, here.

No comments:

Post a Comment