If you will be hitting retirement age soon or perhaps thinking about retirement plans, you have probably heard the term IRA. IRA stands for Individual Retirement Account. It is a tax advantage account that is made to help you in saving for your retirement. There are two types of IRA – The Roth and the traditional one. Investing in IRA has its benefits because it can supplement your current saving and take advantage of the power of compounding. Starting an IRA is very easy. All you need is to open an account and give your funds, then choose an investment, contribute yearly and monitor the performance.
When choosing the best for you, it might be a little confusing especially if you are not familiar with the terms. These two have their differences and advantages as well. It is a good idea to research things when it comes to choosing the type of IRA that can best suit your financial situation. Knowing some information will definitely result to good investment that won’t cost a lot in the future.
If are going to compare this two, think about the situation that can benefit you. There is a calculator that can help you know the difference. If you are young and facing high income taxes, then traditional IRA is a good choice. If you can forego the tax saving while you are still young, you can certainly reap the benefit when you are older. Roth IRA can make it happen that any income coming later in life is tax free.
It is normal to consider a lot of thing before making any decision. It is important to take note that you if you withdraw funds before reaching the age of 59 then you will have to pay a penalty. Certainly there are exceptions but it is better not withdraw anything before reaching that age. It is a different matter when it comes to Roth IRA because you can withdraw funds before the age of 59 and you need to have that fund in place for five years. Meaning if you don’t invest until you are 55, you can get it only when you are 60.
Here is a quick summary of Traditional IRA and Roth IRA.
Deductibility
- Roth IRA: The contributions are not deductible.
- Traditional: It may be deductible depending on three things – tax filing, active participant status and income amount.
Age Limitations
- Roth IRA: Got no age limitations when it comes to contribution.
- Traditional IRA: When taxpayer hits the age of 70, contributions are not allowed.
Income Caps
- Roth IRA: It got an income caps that can prevent tax payers from contributing.
- Traditional IRA: no income caps that may prevent contribution.
Treatment of Earning on IRA Investments
- Roth IRA: earnings can grow tax deferred. Its qualified distribution is tax free including distribution of earnings.
- Traditional IRA: earnings grow on a tax deferred basis and added to taxable income every year.
Distribution Rules
- Roth IRA: Distributions are taken anytime. They are tax and penalty free if qualified.
- Traditional IRA: Distribution can also be taken at any time and it is treated like an ordinary income. This can be subjected to penalty if withdrawn early.
Required Minimum Distribution
- Roth IRA: the owner of the account is not subjected to these rules but its beneficiaries are.
- Traditional IRA: The owner must begin to distribute the minimum amount when they turn 70 and their beneficiaries are also subjected to the RMD rules.
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Comment by Jen — June 24, 2008 @ 10:51 pm