IRA or Roth IRA - Which is right for you?
Individual Retirement Accounts are important tools for building a secure retirement. Deciding whether a Roth or Traditional IRA is right for your situation can be complex. Variables such as deductibility of your contribution, your tax bracket now and at the time of retirement, how long it will be before you retire, and when you plan to start taking distributions are all considerations.
Generally, Traditional IRA contributions are tax-deductible, and grow tax-deferred. This means you won't pay taxes on your contributions until you withdraw them, presumably at retirement. When you do withdraw the funds, you'll pay taxes on both your contributions and the earnings.
You don't get a tax deduction when you make a contribution to a Roth IRA, but the beauty and power of Roth IRAs is that the earnings are always tax-free. This tax-free growth, and the fact that Roth IRAs are not subject to the minimum distribution rules requiring withdrawals after age 70 1/2, are their major advantages.
Even if you're eligible to contribute to a tax-deductible Traditional IRA, you may benefit over the long run by investing in a Roth IRA instead.
The tax advantage of a Roth IRA increases with the number of years between the time you establish the Roth IRA and the time you begin taking distributions. To really determine whether you will come out ahead with a Roth, you have to do some number crunching and look at your total investment picture. Talking with a tax professional about your situation is highly recommended.
Traditional: Anyone under the age of 70 1/2 with earned income can contribute.
Roth: You must have earned income to contribute, but there is no age restriction.
The contribution limits for both types of IRAs are the same. In all cases, contributions must not exceed earned income. In 2018, the contribution limit is $5,500 and will likely be adjusted for inflation in subsequent years. In 2017, workers aged 50 and over are allowed to make additional "catch-up" contributions of $1000*.
Deductibility of Contributions
Traditional: Contributions are deductible if you do not participate in another qualified plan. If you are a plan participant, contributions may be deductible depending on your Adjusted Gross Income (AGI). For 2018 contributions - single return filers - full deductibility if AGI is $63,000 or less and partial deductibility with AGI up to $73,000. For joint return filers in 2016, the limits are $101,000 and $121,000*.
Roth: Contributions to a Roth IRA are not tax deductible.
Taxability of Earnings
Traditional: Any earnings and deductible contributions are subject to tax when you withdraw the funds.
Roth: All qualified distributions from a Roth IRA are tax-free.
Penalty for Early Withdrawals
Both types of IRAs impose a 10% early withdrawal penalty tax on distributions taken before reaching age 59 1/2. There are a few exceptions for death, severe hardship and other situations.
In addition, Roth IRAs also have a "5 year rule", meaning that the account must be established for 5 years or age 59 1/2 (whichever is longer), to avoid the 10% penalty.
Traditional: You must start taking distributions in the year you reach age 70 1/2.
Roth: In most cases, Roth accounts do not require mandatory distributions.
Should You Convert Your Traditional IRA to a Roth IRA?
There are some special rules that allow you to convert a Traditional IRA into a Roth IRA. Many people find that the attractions of tax-free distributions and no required distributions make a Roth IRA conversion worth considering. However, converting a Traditional IRA to a Roth IRA does require you to pay tax upfront on the amount in the account. Be sure to consult your tax advisor to determine if converting makes sense.
We can help
If you have additional questions, visit one of our branches or call us at 1-800-288-3425. We can help you determine which type of IRA is right for you, and start you on the path towards achieving your retirement goals.
*Note: contribution amounts and income limits are subject to change yearly.
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