How Roth and Traditional IRAs Will Differ This Tax Season

tax season 2016

Traditional IRAs
A Traditional IRA not only offers tax-deferred growth, but it also offers tax-free contributions. Usually, you will get a tax break for the that you contributed to your IRA, and you don’t have to pay taxes until the day you retire, and start taking distributions. Keep in mind though that your distributions will be taxed as regular income.

Roth IRAs
One of the biggest downsides to a Roth IRA compared to a Traditional IRA, is that Roth doesn’t give you a tax break right up front. That’s because Roth contributions are made up of after-taxes money, so if you’re seeking out a way to lower your current tax burden, and Roth IRA might not be for you. On the flip-side, when you’re ready to take retirement distributions from your Roth IRA, your money won’t be taxed as you withdraw money, so all the investment gains are for you to keep.

Required minimum distributions
Another factor to contemplate when comparing IRAs is mandated withdrawals from your plan. Currently, traditional IRAs force you to start taking required minimum distributions (RMDs) once you turn 70-1/2. This can be problematic if you’re at a point in your life where you don’t need the money, since your RMD will automatically trigger a tax situation.

Imagine, for example, that you decide to work until age 75, and therefore don’t need to tap your retirement savings until then. With a traditional IRA, you’ll be required to take an initial withdrawal by April 1 of the year following the calendar year in which you turn 70-1/2, regardless of whether you want or need it. Not only will you lose out on the opportunity to keep that money invested, but that extra cash could bump you into a higher tax bracket if you’re bringing in a solid salary already.

But you can’t ignore your RMD either. If you fail to take your required distribution, you’ll be assessed a 50% penalty on whatever amount you neglect to withdraw. All of this highlights another tax benefit of the Roth IRA. Because Roth’s don’t impose RMDs, you can leave your money invested indefinitely.

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