You may want to set-up a retirement account because you know you need to save but, you may be stuck on which one to choose. Two of the most sought after retirement accounts are Roth and Traditional IRA. Both are very useful tools in saving for retirement. But to choose between the two will depend largely on your needs and preferences. Although both have their benefits, they also have their share of disadvantages. Here is a list of pros and cons to help you weigh between Roth vs. Traditional IRA and see which one will benefit you the most.
Roth IRA is a retirement plan whose distributions are tax-free (subject to some requirements) but the contributions are not. It can contain different kinds of investments like stocks, bonds etc.
After five years from the creation of the account, withdrawals of earnings can be made and are tax-free. Any of the conditions below must apply:
You are at least 59 ½ yrs. of age
You are disabled
Distributions are meant to build your first home.
Distributions are made in favor of a beneficiary after your death.
You are not required to make withdrawals even after the age of 70½. If you can get by without making withdrawals then you can keep the money in your account for as long as you like.
You can withdraw all qualified distributions tax-free and are not treated as additional income.
Roth IRA distributions can be inherited. Qualified beneficiaries can make withdrawals after your death.
There is no age limit to be able to contribute to Roth IRA.
Contributions will not be deducted from your income tax.
There is an income limit imposed to be eligible to contribute to Roth IRA. Your income should be less than the income limits listed below:
$183,000.00 for married filing jointly or a qualified widow or widower.
$125,000.00 for head of the household or single or married filing separately and not living with your spouse within the year.
$10,000.00 for married and filing separately but lived with your spouse within the year.
Not favorable if your income falls in the high income bracket since Roth IRA contributions cannot be deducted from your income tax at present when your income is high.
If your Modified Adjusted Gross Income (MAGI) is within the phase-out rates, the maximum amount you can contribute may be lessened.
Traditional IRA is another type of individual retirement account whose contributions are tax-deductible. In Roth vs. Traditional IRA, traditional IRA is more lax when it comes to eligibility wherein you just need to have enough income to be qualified and no income caps are imposed.
The biggest advantage of Traditional IRA is its feature of having its contributions tax-deductible. The amount you can deduct is the amount that is lesser of these two conditions:
Contributions within the year
The general limit ($5000 for those below 50 yrs. old and $6000 for those above 50) or spousal limit whichever is the case.
Everyone who has a sufficient income is allowed to set-up a Traditional IRA.
This type of retirement account is best if you fall in the high income bracket while you are still working. If you think that you will fall in the lower income bracket after retirement then it is best to pay taxes in the future and take advantage of the tax-deductible contributions now.
Distributions are considered as income and therefore taxable.
Early distribution penalty of 10% is imposed if you are going to make withdrawals before you are 59½ yrs. old.
Certain restrictions apply to avail of the tax benefits. Deductions may be reduced or may not be allowed based on your income, if you or your spouse is covered by an employer retirement plan.
Compulsory distributions are enforced from the age of 70½.
No contributions will be accepted after you reach the age 70½.
Which Individual Retirement Account is right for you?
Author Bio: YFS is owner and author of Your Finances Simplified. He was born and raised in West Philadelphia and is now a financial adviser, IT contractor, landlord, and treasurer of a non-profit. He created his blog partly due to his desire to help people with their finances.