Whether you decide on Roth IRA, traditional IRA, or both, there are financial implications to consider. Along with IRA basics, the following are some important differences between these two retirement accounts, and other factors to consider when choosing the account that's right for you.
Roth IRAA Roth IRA is a special type of individual retirement plan that is generally not taxed, provided certain conditions are met. Roth IRAs provide no tax break for contributions, but earnings and qualified withdrawals are generally tax-free. So with traditional IRAs, you avoid taxes up to the contribution limit when you put the money in. With Roth IRAs, you can avoid taxes when you take it out in retirement.
Roth contributions (not earnings) can be withdrawn penalty- and tax-free anytime, even before age 59½. Five tax years after the first contribution, you can withdraw up to $10,000 of Roth earnings penalty-free to pay for qualified first-time homebuyer expenses.
You can make contributions to your Roth IRA after you reach age 70½ and you can leave amounts in your Roth IRA as long as you live. Also, all qualified distributions are tax-free, but as with any other retirement plans, non qualified distributions from a Roth IRA may be subject to a penalty upon withdrawal.
Traditional IRAWith a traditional IRA, you may be able to deduct some or all of your contributions from your taxable income, and may also be eligible for a tax credit equal to a percentage of that contribution. Amounts in a traditional IRA, including earnings, generally are not taxed until distributed. Amounts you withdraw from your IRA are fully or partially taxable in the year you withdraw them.
Contributions to traditional IRAs lower your taxable income in the contribution year. That lowers your adjusted gross income, helping you qualify for other tax incentives you wouldn't otherwise get, such as the child tax credit or the student loan interest deduction. You can withdraw up to $10,000 without the normal 10 percent early-withdrawal penalty to pay for qualified first-time homebuyer expenses. However, you'll pay taxes on the distribution.
You can set up a traditional IRA at any time and make contributions as long as you were under age 70½ at the end of the tax year, and you (or your spouse, if you file joint return) received taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment.
Individual Retirement Account summaryFor some, their eligibility to deduct traditional IRA contributions can be the deciding factor in choosing between a Roth and traditional IRA. However, being eligible to deduct your contribution doesn't mean that the traditional IRA is the better choice. Consider whether the benefits of the Roth IRA - such as tax-free qualified distributions - outweigh the benefits of a deduction. Finally, you may want to consider splitting your contribution between both types of IRAs and enjoy the benefits of both.
Always consult with a financial advisor or insurance professional before determining which option is best for you, your retirement planning and your financial situation.