You are saving for retirement and are on the path toward building your nest egg to provide income when you stop working. One common vehicle for savings is the IRA. Often our clients are confused about the difference between Traditional and Roth IRAs. Here is what you need to know:
Individual retirement accounts (IRAs) are tax-advantaged vehicles designed for long-term investing and saving. Commonly, these are used to build funds to create retirement income in the future. The two most common IRAs are designed for individual investors to use on their own, rather than rely on an employer sponsored fund. While they are similar, they differ in how they are taxed (do you want to pay taxes now or later?), accessibility of funds, and eligibility standards. Knowing these key differences will help you decide which is right for you.
Traditional IRA contributions are tax-deductible on both state and federal tax returns for the year you make the contribution. As a result, withdrawals are taxed at your income tax rate when you receive them in retirement. Contributions can lower your taxable income (adjusted gross income). If you withdraw money before age 59½, you’ll pay taxes and a 10% early withdrawal penalty.
You don’t get a tax deduction when you contribute to a Roth IRA. It will not lower your adjusted gross income. However, withdrawals from a Roth IRA during retirement are tax-free. Because you have already been taxed on this money, you will not have to pay taxes when you take money from the account. Roth IRAs have income-eligibility restrictions depending on maximum adjusted income. These restrictions vary from year to year.
Roth IRAs carry no required minimum distributions, which means you’re not required to withdraw any money at any age or during your lifetime at all. This makes them a great way to transfer wealth. Beneficiaries of Roth IRAs don’t owe income tax on withdrawals, either, though they are required to take distributions or else roll the account into an IRA of their own. You are allowed to withdraw sums equal to your Roth IRA contributions penalty and tax-free at any time, for any reason.
What’s the Difference?
Both traditional and Roth IRAs provide generous tax breaks. But it’s a matter of timing when you can claim them. The key is in the timing of their tax advantages. With traditional IRAs, you deduct contributions now and pay taxes on withdrawals later while Roth IRAs allow you to pay taxes on contributions now and get tax-free withdrawals later. Traditional IRAs function like pensions by offering tax breaks, however, they restrict access to funds. Roth IRAs function more like regular investment accounts, but include tax benefits: They have fewer restrictions, but fewer breaks as well. When choosing the right IRA for you, you must consider if you will be in a higher or lower tax bracket when you retire.
IRAs don’t have to be confusing. Choosing the right one for you must be carefully considered and be part of a larger retirement plan to achieve your goals. If you need help, we are here. At Blue Waters Financial Group, we are committed to helping our clients achieve all their retirement goals and plan for the future. To schedule your no-obligation meeting and discuss your retirement income plan, just click on the link below or call us today at 704-790-2583 (BLUE).
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