This guest blog post was written by Brandon Langston of RothIRA.com. RothIRA.com aims to provide consumers free, relevant information about why the Roth Individual Retirement Account makes sense for so many investors. We’d love to answer your questions or hear more from you on twitter or our blog.
Should I Get a Roth IRA or Traditional IRA?
The state of the economy has a lot of people thinking short term, which of course is needed for immediate survival, however long term financial goals cannot be overlooked as a result. Saving for retirement is just as important now as ever before and despite current financial concerns, should be a priority for every individual. If you are considering which type of investment vehicle is right to meet your long term goals, individual retirement accounts (IRAs) will certainly be an option to consider.
IRAs are available in several forms. The two main types of IRAs that you must first decide between will be a Roth IRA or a traditional IRA. Both IRAs are excellent options to save for your retirement years, however they have distinct differences which should be understood before making the final decision.
Roth IRA– To qualify for a Roth IRA you must be able to make contributions from taxable earned income. This may be in the form of wages, salaries, commissions or self employment. You may not make contributions with monies received from royalties, investments or other non-taxable income. In addition to this requirement, individuals or couples must also meet income requirements in order to open and contribute to a Roth IRA. These restrictions change from year-to-year and are generally based on your modified adjusted gross income and tax-filing status. Information on eligibility requirements can be found on the IRS website.
Traditional IRA– The requirements for opening a traditional IRA are similar to that of the Roth IRA in terms of making contributions from earned taxable income. With a traditional IRA the only other requirement for eligibility is that you must be under age 70 1/2 at the end of the year in which you are contributing to the account.
Roth IRA– Contributions to a Roth IRA are not tax-deductible. If you earned $30,000 and made $1,500 in contributions, you would be required to pay income tax on the full $30,000. While you do not see an immediate tax break with a Roth IRA, the benefit comes later when you withdraw money from that account. Contributions can be withdrawn at any time without incurring taxes. You can withdraw both contributions and earnings tax free if you are age 59 1/2 and the Roth IRA has been opened for five tax years. This means that if you’re receiving qualified distributions you will never pay income tax on any money taken from the account.
Traditional IRA– Unlike the Roth IRA, contributions to a traditional IRA are tax deductible. You receive an immediate tax break, however you will end up paying income tax on money at the time of distribution. If you withdrawal money from your traditional IRA prior to the age of 59 1/2 (barring any exclusions) you will be responsible for paying both income tax as well as a early withdrawal penalty of 10%.
Roth IRA– As previously mentioned qualified distributions will not incur any taxation and you are not required to withdraw your money at any time. The account can remain open, giving your investments time to grow, for the remainder of your life.
Traditional IRA– You may begin taking money from your traditional IRA without penalty at age 59 1/2. When you reach age 70 1/2 you will be required to withdraw a minimum amount of money from the account or face a stiff penalty from the IRS. When required distributions are not made, they are subject to an IRS excise tax of 50%.
As you can see, both forms of individual retirement accounts offer specific benefits as well as drawbacks to the contributor. It is up to you to decide which option will work best for your current and anticipated financial situation.