As you start to plan for your retirement one of the first hurdles that you need to get over is to decide what type of retirement account that is right for you. Whether you already have a 401k and are maxing that out as much as you can or if a 401k is not available for you typically the next best retirement account is an IRA. It isn't quite as simple as just choosing an IRA and investing in it. You also have to choose the type of IRA account that you want, a Roth IRA or a Traditional IRA. Many people don't know enough about the differences between a Roth and Traditional IRA to be able to figure out which one is right for them. We would like to help you learn the basics of a Roth and Traditional and the things that make them different so that you can choose the IRA that is right for you.
- Each year you can contribute $5,500 to your IRA, plus an additional $1,000 for catch-up contribution if you have reach age 50 or older.
- Roth IRA contributions are never eligible to deduct contributions and in turn get a tax break for the year you made the contribution.
- There are no age limits to contributions.
- Your salary helps determine the amount you can contribute to your Roth IRA. For example, If your tax-filing status is single and your MAGI income exceeds $127,000 you may not contribute to a Roth IRA. If you make between $112,000 to $127,000 you must use a special formula to determine the dollar amount that you may contribute to your Roth IRA (this is called a "phased out" contribution). Talk with your tax accountant to find out what your contribution limit is based on your income.
- Roth IRAs are not subject to required minimum distributions (RMDs). Meaning that you aren't ever required to distribute a certain amount of your IRA to you.
- When taking a distribution from your IRA they are generally tax and penalty free as long as you have either reached 59.5, you are disabled, your beneficiary receives the distribution upon your death or the amount is used to purchase your first home.
- Just like Roth IRAs each year you can contribute $5,500 to your IRA, plus an additional $1,000 for catch-up contribution if you have reach age 50 or older.
- You are potentially eligible to deduct Traditional IRA contributions and in turn get a tax break for the year you make the contribution. In order to receive that tax break though you must meet certain requirements.
- You can only contribute to your Traditional IRA until you reach the age 70.5.
- There are no limits to contributions based on your income.
- Traditional IRAs are subject to required minimum distributions (RMDs). You must begin to take RMDs by April 1 of the year following the year you reach age 70.5. Regardless if you need the funds you must start taking this distribution.
- Traditional IRA contributions are generally treated as ordinary income and subject to income taxes. If you withdraw from your IRA before 59.5 you may be subject to early-distribution penalties.
These are just a few of the differences between Roth IRAs and Traditional IRAs. Also as a general rule a Roth IRA is the better choice if your tax rate during retirement will not be lower than your current tax rate because the Roth IRA allows you to pay the taxes now, and receive tax free distributions when your income tax rate is higher. If you think your tax rate will be lower during retirement then the traditional IRA may be the better choice as Traditional IRAs allow you to receive a tax deduction now when your tax rate is higher.
One thing to remember when going through this process is that both of these types of accounts can also be self directed allowing you to invest in the types of investments that you want like gold, real estate or even private equity.
If you need more information about Roth IRAs or Traditional IRAs or are curious how a self directed Roth IRA or self directed Traditional IRA work we can help. Contact us today.
Author: Nick Barker