When it comes to retirement savings, there are many options available to you. One of the most popular and beneficial options is a Roth IRA. A Roth IRA is an individual retirement account that allows you to save money after taxes, and your money grows tax-free. Withdrawals during retirement are also tax-free, and there are no mandatory minimum distributions (RMDs) during your lifetime, making Roth IRAs the ideal wealth transfer vehicles.
In some cases, a traditional IRA or 401(k) may have a strong appeal. Often, choosing between one or the other depends on how much you earn now and how much you expect to contribute once you stop working. With a traditional or 401(k) IRA, you invest with pre-tax dollars and pay income taxes when you withdraw money in retirement. This means that you will pay taxes both on the original investments and on what they earned.
A Roth does just the opposite. You invest money that has already been taxed at your regular rate and withdraw it with your tax-free earnings when you retire, provided you have had the account for at least five years. On the other hand, if you choose a traditional or 401(k) IRA, you have to divert less of your income to retirement in order to make the same monthly contributions to the account because Roth would essentially require you to pay both the contribution and the taxes you paid on that amount of income. That's an advantage for a traditional account, at least in the short term. If your income is relatively low, a traditional or 401(k) IRA may allow you to get more contributions to the plan as a saver tax credit than you will save with a Roth.
A traditional or 401(k) IRA can result in a lower adjusted gross income (AGI) because your pre-tax contributions are deducted from that figure, while after-tax contributions to a Roth are not. And if you have a relatively modest income, that lower gross gross income can help you maximize the amount you receive from the saver's tax credit, which is available to eligible taxpayers who contribute to an employer-sponsored retirement plan or a Roth or traditional IRA. There is another reason to opt for a Roth and it relates to access to income now versus potential tax savings in the future. A Roth can take away more income from you in the short term because you are forced to contribute in dollars after taxes. In contrast, with a traditional or 401(k) IRA, the income needed to contribute the same maximum amount to the account would be lower, because the account is based on pre-tax income.
The result is that a traditional retirement account increases your financial flexibility and allows you to make the maximum allowable IRA or 401(k) contribution while you have extra money on hand for other purposes before you retire. Yes, if you're married and filing a joint return, your spouse can open their own Roth IRA (a spousal IRA) and fund it separately from your own, even if you don't have any earned income. The combined income of both spouses is treated the same, even if one spouse generates 100% of the income and the other spouse generates 0%. The main difference between a Roth IRA and a traditional IRA is how and when you get a tax exemption. Contributions to traditional IRAs are tax-deductible, but retirement withdrawals are taxable. By comparison, contributions to Roth IRAs are not tax-deductible, but retirement withdrawals are tax-free.
At age 72, there are mandatory minimum distributions (RMD). Unless you meet an exception, early withdrawals of earnings may be subject to a 10% penalty and income taxes. Roths allow contributions to be withdrawn at any time. It's hard to anticipate what your tax rate will be in retirement, especially if you're decades away from leaving the workforce. Fortunately, there are other ways to determine if a Roth or traditional IRA is best for you.
How much of your contribution to a traditional IRA you can deduct from this year's taxes? The deductibility of the traditional IRA is restricted only if you or your spouse has access to a workplace savings plan, such as a 401(k).These income limits apply only if you (or your spouse) have a retirement plan at work. The limits are based on modified adjusted gross income, which is your adjusted gross income with some aggregate deductions. See IRS Publication 590-A, Worksheet 1-1, for instructions on how to calculate the MAGI for traditional IRAs. See IRS Publication 590-A, Worksheet 2-1, for instructions on how to calculate MAGI for Roth IRA. Traditional IRAs may be beneficial for those who qualify.
To get out even in terms of after-tax savings, you need to be disciplined enough to invest the traditional IRA tax savings you get each year into your retirement savings. If that seems unlikely to happen, then it may be better for you to save on a Roth where you'll reach retirement with more after-tax savings. If you make an early withdrawal from a traditional IRA before age 59 and a half, then it's likely that both an income tax bill and 10% early withdrawal penalty will apply. There are some exceptions; read more about traditional IRA withdrawals. RMDs increase your income later in life which can increase your tax bill and affect other proven income-driven benefits such as Medicare premiums. The option of leaving your Roth IRA savings intact gives great benefit over other retirement vehicles.
No matter what stage of life you're in it's never too early to start planning for retirement as even small decisions made today can have big impacts on your future. While investing in an employer-sponsored plan is important an Individual Retirement Account (IRA) allows additional savings for retirement as well as potential tax savings. There are different types of IRAs with different rules and benefits but with a Roth IRA contributions are made after taxes and withdrawals during retirement are generally tax-free and penalty free after age 59.
