Roth IRA vs Traditional IRA: What You Need to Know
Posted on December 15, 2016
Do you know the difference between a Roth IRA and a
Traditional IRA? Maybe you’re looking into getting one, but aren’t sure which
is right for you. Perhaps you already have one or the other, but want to fill
in some gaps in your knowledge. For example, did you know you must begin
withdrawing when you turn 70 ½ if you have a traditional IRA?
Planning your financial future can be intimidating. However,
it’s a very necessary and crucial step towards becoming
worry-free and financially stable. If you’re among the many who are
stumped about their retirement plans, let Alert1 give you some advice on your
What is an IRA?
IRA stands for ‘Individual Retirement Account’. They are used to
save money for your retirement. IRAs are types of savings accounts that come
with tax breaks. There are two different
kinds of IRAs will discuss today: Roth and Traditional.
IRAs are often confused with 401ks. The IRA is a private
retirement plan you set up yourself; 401ks are provided by your employer.
How Does the Roth Compare to the Traditional?
The Roth IRA and Traditional IRA both have their own unique
- You pay taxes on your contributions at the time
you make the contribution.
- You can withdraw your contributions at any time.
However, you can only withdraw your principal contributions, you cannot
withdraw any gains.
For example, let’s say you’ve had
your Roth IRA for 2 years. Each year you contributed $1,000. Then you have a 5%
gain of $100, and your account now has $2,100.
You now decide to withdraw. You’re entitled
to withdraw only $2,000 – this is your principal contribution. You will not be
able to withdraw the $100 gain.
- All withdrawals are tax-free.
- You are not required to make any required minimum
distributions (RMDs) when you turn 70 ½ years old. An RMD is a required amount
that you must withdraw each year.
- If you are 49 years and under, the contribution
limit is $5500 per year.
- If you are 50 years and older, the contribution
limit is $6500 per year.
- Contributions are tax deferred, meaning you pay
taxes when you withdraw your contribution.
- If you withdraw before the age of 59 ½ years old,
you will be penalized. There is a fee of 10% of the withdrawal amount.
- When you turn 70 ½ years old, you must withdraw an
RMD based on size of your IRA and begin paying taxes.
- Like Roth IRAs, if you are 49 years and under, the
contribution limit is $5500 per year.
- Also the same as Roth, if you are 50 years and
older, you can contribute up to $6500 per year.
Which One is Right for Me?
Some people will prefer a Roth IRA over a Traditional IRA, and
vice versa. Others may prefer to have both types of IRAs. If you’re not sure
what kind of IRA is right for you, we have some recommendations to help narrow
down your choice.
The first important thing to consider is which income bracket
you’ll be in in the future. If you believe you’re likely to be in a lower income
bracket in the future, a Traditional IRA is for you. This is because with a Traditional
IRA, you’ll only pay taxes at the time of withdrawal. If you’re in a lower
income bracket at the time of withdrawal, you’ll pay a smaller amount in taxes.
If you believe you’re likely to be in a higher income bracket in the future, a
Roth IRA will be more beneficial for you. This is because you’ve already paid
your taxes when you made your contributions. Let’s say you’re in a higher
income bracket in the future with a Traditional IRA. The result is you’d be
paying a much heavier amount in taxes during withdrawals.
Another important thing to consider is withdrawal flexibility.
If you’ll need flexibility for withdrawals, you’ll want to choose a Roth IRA.
The Roth IRA does not penalize you for withdrawals and you can withdraw at any
time. With a Traditional IRA, you can’t make withdrawals until the age of 59 ½ without
With a Roth IRA, there are income limits. If you exceed these
income limits, your only option will be a Traditional IRA. For single
contributors, the income limit is $117,000 per year. For
married contributors, the joint income limit is $184,000.
A tip for
The contribution limits for both the Roth and Traditional IRA
per year are equal ($5500 for 49 year olds, $6500 for 50+ year olds). Your contributions
will depend on what you’re able to contribute according to your financial
status. However, it’s recommended to contribute the maximum amount each year.
The more you contribute, the more gains you have that are tax-protected.
Plan for the Future Today
Now, you have a better insight on your individual retirement
plan. Whether you’re in your 20s or your 50s, understanding your retirement
plan options is always important. Here at Alert1, we highly
recommend that you take control of your financial future today. 1 in 3
Americans have $0 saved for retirement. Don’t contribute to this statistic –
instead, contribute to your IRA!
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