Understanding the differences between Individual Retirement Accounts
Currently, there are two popular Individual Retirement Accounts (IRAs) that you might consider: the traditional IRA and the Roth IRA. While both are long-term savings vehicles with tax benefits, each has different rules concerning contributions, age, and income that may change from one year to the next.
Perhaps the biggest difference between traditional IRAs and Roth IRAs is how and when taxes apply to the contributions and earnings. Contributions to traditional IRAs can be pre-tax (deductible on the taxpayer’s income tax return). Although contributions and earnings accumulate on a tax-deferred basis, income taxes are due when IRA distributions are taken.
On the other hand, contributions to Roth IRAs are made with after-tax dollars, and contributions and earnings accumulate tax free. No income tax is due when distributions are taken from a Roth IRA. For tax year 2021, the maximum contribution to either a traditional IRA or Roth IRA is $6,000 ($7,000 for individuals age 50 or older).
As you investigate which IRA – or combination of IRAs – offers you the best bottom line, you may want to consider the differences, as the simple IRA checklist highlights.
A Simple IRA Checklist
|
Roth |
Traditional |
10% penalty for withdrawals prior to age 59 ½ |
Yes |
Yes |
Tax deductible contributions |
No |
Yes |
Tax-deferred accumulation |
Yes |
Yes |
Tax-free distribution |
Yes |
No |
Mandatory minimum withdrawals required to start at age 70 ½ |
No |
Yes |
It is important to note that withdrawals after age 59½ may be taxable if the Roth IRA has not existed for at least five years and penalty-free withdrawals can be taken in certain situations, but additional rules apply. Further, contributions to a traditional IRA are tax deductible up to certain limits.
Your Financial Professional
An analysis of your personal financial situation and retirement objectives with a qualified financial professional can help you develop a financial strategy to manage your specific needs. Scrutinizing the details now may save you time and money in the future.
Important Disclosures
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial professional prior to investing.
Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.
The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.
This article was prepared by FMeX.
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