Roth vs. Traditional IRA Accounts
Traditional and Roth IRA accounts have many similarities and differences that may influence how you save for retirement. Most people who have a 401k plan from their employer chose a Roth over a Traditional account. Self-employed individuals tend to invest into a Traditional IRA first.
Similarities
Since both Traditional and Roth IRA accounts are designed to help individuals save for retirement, the accounts have many similarities.
- Both accounts are designed for individual savings for retirement
- Both accounts protect the investments from taxes
- Both accounts have maximum annual contribution limits
- Both accounts can hold whatever asset class you chose
- Both accounts can be opened at almost any financial institution
Differences
While both Traditional and Roth IRA accounts are designed to help you save for retirement, there are several key differences between the two. The differences may determine where you allocate your money, or you may decide you just want to save the maximum in both accounts, regardless of differences.
- Roth IRA earnings are not reported as income
- Roth IRA Contributions are not Tax Deductable
- Roth IRAs have no age limit for establishing an account
- Roth IRA distributions are not usually taxed
- Roth IRAs have no required distributions
- Traditional IRA withdrawals are taxable
- Traditional IRA contribution tax deductions may be limited if you contribute to a 401k or other employer sponsored program. Contributions to a Roth are limited by your income level.
- Withdrawing Roth IRA contributions incurs no penalty. Traditional IRA withdrawals before the minimum distribution age have a 10% penalty unless it is for certain expenses.
Why Save Post Tax?
Savings for retirement in a Roth IRA with after-tax income may be beneficial to you for several reasons. If you believe taxes will go up in the future, saving after-tax dollars today protects you from the increase. Similarly, if you believe you will retire at a higher income tax bracket than you are currently in, Roth contributions will have been made at a lower tax rate, protecting more of your savings from taxes.
Traditional to Roth Conversion
A traditional IRA can be converted to a Roth IRA in one of three ways: Rollover, Trustee-to-trustee transfer, or Same trustee transfer. Regardless of how you convert, the conversion will be considered income and will increase your AGI. So make sure your conversion does not bump your income high enough to lower your eligibility for a Roth IRA or you will be paying penalties on top of the taxes.
Reasons for converting to a Roth IRA include the possibility you are in a low income year and will pay fewer taxes on the conversion than you would on a distribution from a traditional IRA in retirement or if you believe taxes will go up in the future and want to take advantage of the Roth IRA's post-tax contributions.
Next: Learn about withdrawing from your Roth IRA >>
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