No one can predict the future when it comes to retirement especially as we look at real estate, mortgage rates, savings rates or the stock market. While there are experts can anyone really predict with any great degree of accuracy what’s going to happen? Personally I don’t think so.
But based on past performance, one of the best investments for retirement is an Individual Retirement Account – IRA. There are many types of IRA’s and one of the first questions I know I asked when I started looking at them was which is better: Roth vs. Traditional IRAs.
- Are They Differences
- Traditional IRAs
- Roth IRAs
Are They Differences?
What are the differences between them? Which one is better for you? Although I can’t tell you which one to choose, I can give you a mortgage guy’s rundown on what I know about each one to help you make your own decision. After you read this, your next step ought to be to call a financial planner or tax professional to fill in the gaps from what I have written about here.
Traditional IRAs
Basically, a Traditional IRA is a tax-deferred retirement account. That means contributions to a Traditional IRA may be tax deductible, depending on your income.
One advantage of the Traditional IRA is that, because the money is invested before taxes are paid on it, it potentially allows you to lower your tax bracket at the time of investments. Another advantage is that, when you retire you usually make less money and therefore the taxes you have to pay on your withdrawals will be less. Also, the money grows tax free until you withdraw it.
Here are a few more facts about the Traditional IRA:
- Income limits – Everyone is eligible to own a Traditional IRA, but there are limits on tax deductions you can take.
- Withdrawals – You can start withdrawing from your IRA at age 59 1/2, and your withdrawals will be taxed as regular income. You will pay a 10% penalty for early withdrawal, although there are exemptions to this rule.
- Required minimum distributions – You must make withdrawals starting at age 70 1/2.
Disadvantages of the Traditional IRA include the required minimum distribution, which must be taken whether you need the money or not, and the fact that it isn’t easy to know in advance what your tax rate may be in retirement.
Roth IRAs
While the Traditional IRA is tax deductible, the Roth IRA is tax exempt. That means that, while contributions to the Roth are taxed, withdrawals made during retirement are tax-free. Another advantage is that there is no required minimum distribution.
- Income limits – Unlike a traditional IRA, the Roth has income limits that limit who can participate in the program. Income limits can change every year. You will need to check with your financial planner to see whether you exceed the Roth IRA income limits in any given year.
- Withdrawals – The minimum age to withdraw from a Roth IRA is 59 1/2. The principal can be withdrawn at any time without penalty, however if the interest is withdrawn early there can be penalties. One exemption to early withdrawal penalties is if the IRA owner uses the money as a down payment on a first home (I have had several mortgage customers take advantage of this program feature to buy a home). This is true for both the Roth and Traditional IRA.
Which One Is Better?
So which one is better? Well, there are pros and cons to each. I can’t tell you what is going to be more advantageous to you, so maybe the best course of action would be to discuss it with a financial planner or tax professional.