This guest post was written by Brandon Langston of RothIRA.com. Looking to start a Roth IRA? Learn more with RothIRA.com’s free resources, calculators, and guides today!
There are several types of individual retirement accounts (IRAs) available to aid in retirement savings. Of the close to a dozen different types of IRAs, there are two that are very popular among savers. Both offer unique benefits and each can be a great tool in saving for retirement. Here we take a closer look at the traditional IRA and the Roth IRA.
The traditional IRA is an excellent savings tool that can help individuals and married couples put money aside toward their retirement. One of many IRAs that have immediate tax advantages, the traditional IRA allows for a tax deduction of contributions in the year they are made.
This can be very beneficial to individuals and married couples who are interested in reducing their taxable income for the year, while allowing for tax deferred growth on all contributions.
The drawback of immediate tax benefits however are the income taxes paid on distributions at a later period. If distributions are taken before you reach age 59 1/2 you will be charged a 10% early withdrawal penalty on top of taxation at your current income tax rate.
Eligibility requirements for the traditional IRA are fairly simple; you need only make contributions from taxable income and be under the age of 70 1/2.
Distributions from the traditional IRA have already been covered, however it is important to note that this type of retirement account, requires minimum mandatory distributions once you reach age 70 1/2. If you fail to take the minimum required distribution, expect a 50% penalty on the amount not withdrawn going directly to the IRS.
Now that we know how the traditional IRA works, we can compare it with the Roth IRA. Again, like the traditional IRA, the Roth IRA is also an ideal tool to save toward retirement. That is about where the similarities end.
Contributions to a Roth IRA are not considered tax deductible and will be subject to income tax when you file your income tax return for the year in which contributions were made. While some people find this to be a disadvantage, the long-term benefits are actually very attractive.
Since contributions are made with after tax dollars, you will never again pay income tax on Roth contributions or earnings when you take a qualified distribution. This means contributions to the account can be withdrawn at any time tax-free and earnings from the account are tax-free after you reach age 59 1/2. Earnings taken before 59 1/2 or the five-year anniversary of the account being opened will be subject to 10% penalty.
Contributions must be made from taxable compensation like the traditional IRA, however there are no age restrictions preventing you from contributing to your account once you reach age 70 1/2. In addition, distributions from the account are not subject to the minimum mandatory distribution rule.
This means you can continue to add to your account for the remainder of your life and money in your account can remain there if you choose without fear of a 50% penalty from the IRS.
There are benefits to both types of IRAs which means savers must carefully consider all of the options available before making a final decision.