Roth IRA Vs. Traditional IRA
Many people choose to save for retirement in a Roth IRA or Traditional IRA, but do you know the difference between the two?
Both a Roth and Traditional IRA have a tax incentive but work very differently. When you save in a Roth IRA you pay taxes in the current year and no taxes when you take a qualified distribution. The Traditional IRA allows you to defer all of the tax until the money is withdrawn in retirement. When deciding between a Roth and Traditional IRA you have to decide if it makes more sense to pay tax this year or later in life. When trying to make this decision it is important to consider your future tax rate. If you expect your tax rate to be higher in retirement than it most likely makes sense to contribute to a Roth IRA. But if you are currently in a high tax bracket and expect to move to a lower tax bracket in retirement, it can make more sense to contribute to a Traditional IRA. Sometimes it can be beneficial to have both a Traditional and Roth IRA so that you can have some control over how much taxable income you will have in retirement.
Who can contribute?
Anyone who is under age 70.5 and has earned income is eligible to contribute to a Traditional IRA (Tax Deductibility will vary based on income); however, to contribute to a Roth IRA, there are income limits. If you are a single tax filer you must have modified adjusted gross income (MAGI) of less than $132,000 in 2016 (phase-out begins at $117,000). Married couples filing jointly must have a MAGI of less than $194,000 in 2016 (phase-out begins at $184,000).
When can you withdraw?
Both Roth IRAs and Traditional IRAs allow the owner to take qualified distributions without penalty at age 59½. If you take a distribution before age 59½, you may be subject to a penalty and tax. Even though you can take money penalty free at age 59½, it does not mean you are required to. You are allowed to keep money in a Roth IRA for your entire life without any withdrawals. Traditional IRAs, however, must take a required distribution when the owner reaches age 70½. This amount is based on your age, and there is a penalty if you do not take out the required amount each year.