Deciding Bewteen a Roth IRA Versus a Traditional IRA
Trying to make up your mind on whether to open a Roth IRA versus a
Traditional IRA? Can’t figure out which is best for you? Don’t worry,
you’re not alone! Deciding between a Roth IRA versus a Traditional IRA
is a major decision with potentially hefty financial consequences. It’s
not surprising you might feel overwhelmed trying to decide which IRA is
the right one for you. Both IRAs are great ways to save for retirement,
but each one offers unique advantages that should be first be considered
before you decide which is best for your retirement.
ROTH IRA: TAX-EXEMPT
Understanding the differences between a Roth IRA versus a Traditional IRA basically boils down to when the government is going to tax your money, now or later? When comparing a Roth IRA versus a Traditional IRA it’s important to understand that when money is first invested in a Roth IRA, it is federally taxed based on the tax bracket one inhabits at that time. Unlike a contribution to a traditional IRA, a Roth IRA contribution is never tax deductible. So for example, if you earned $50,000 and contributed $2000 to your Roth IRA, you would still be taxed for $50,000 for the year. However, when you withdraw money from a Roth IRA, none of it, including the earnings, will be taxed, assuming that the Roth IRA has been open for at least five tax-years and you are older than the age of 59 1/2. That’s probably the biggest differences between a Roth IRA versus a Traditional IRA – the funds are taxed going in but not when they are withdrawn. Or in other words, the Roth IRA offers tax-exempt savings rather than simply tax-deferred savings as one would encounter with a traditional IRA.
TRADITIONAL IRA: TAX DEFFERED
In the case of a Traditional IRA, the money is not taxed initially at the time of deposit, but instead when you eventually withdraw money for your retirement (after age 59 ½), then, and only then, will the money be taxed as income at your ordinary income tax rate. So, to use the example from above, if you earned $50,000 and made a contribution of $2000 to your Traditional IRA, you would be able to deduct $2000, leaving you to pay income taxes on $48,000 for the year. Your deposit will grow free of tax throughout the years and when you finally make a withdrawal for your retirement, that’s when it will be taxed as part of your income. In this case the savings would be considered tax-deferred. The benefit to making a pre-tax investment is that it has the potential to lower your current tax bracket, while leaving your money to grow tax free until you withdraw it. So, as you can see, with a Roth IRA versus a Traditional IRA, perhaps the main difference is simply whether you pay the piper now or later.
DON’T BE AFRAID TO CONSULT AN EXPERT!
Even with understanding the differences between a Traditional and a Roth IRA, figuring out the logistics of it all can still be quite daunting for the average person. That’s why it’s important to consult with a retirement planning expert who can advise you the best tax implications for you based on your individual circumstances when considering the benefits of a Roth IRA versus a traditional IRA.