How does one design his future? It is a known fact that the future is uncertain and nobody can really be too sure of what it holds. We can never tell what it will bring, but one way or another we can be ready for it.
One smart way to achieve a well-established future is by making sure that you saved enough for a secure retirement. One vehicle that helps you accomplish this is called an IRA or Individual Retirement Arrangement. It is a retirement plan that comes in many types. Among the various types, endless comparisons are made between Roth vs. Traditional IRA.
(Related article: An in-depth view on Roth vs. Traditional IRA)
Can one of these types possibly be right for you?
Amidst the comparison between its definitions, offers, advantages and disadvantages, perhaps you should also take into consideration its similarities and differences to better differentiate between the two and get a better picture of both arrangements. This can be a good starting point for you to jump start your search for a good investment tool for the future.
What are the similarities of Roth vs. Traditional IRA?
Much has been said in comparing a Roth vs. a traditional IRA, but they actually have many similarities. The Roth IRA is patterned after the Traditional IRA with new added perks but also additional limits.
INCOME: Both Roth IRA and Traditional IRA require you to have compensation or earned income from working before you are allowed to apply for an account.
BASIS OF CONTRIBUTION: Contributions to both IRAs are based on the earned income. Earned income means the amount you earn for your work. It includes salaries, income from self-employment, tips, bonuses, commission and even alimony, but it does not include dividends, interests, rentals, pension, capital gain etc.
CONTRIBUTION LIMITS: Both types have a contribution limit of $5000 and additional catch-up contributions of $1000 by the age of 50.
USE OF FUNDS: Many investments like stocks and bonds can be bought through the use of funds from Roth or Traditional IRA.
What are the differences of Roth vs. Traditional IRA?
Due to Age: Anyone with earned income may contribute to a Roth IRA regardless of age while the Traditional IRA imposes an age restriction regarding eligibility to contribute. For individuals 70½ or older, you are not allowed to open a Traditional IRA anymore.
Due to Income: Although with Roth vs. Traditional IRA, both require an earned income to open an account, Roth IRA imposes restrictions based on how much you earn before you are allowed to open account.
Restrictions are as follows: (If your income is above these limits you are not eligible to make contributions to Roth IRA)
- Married filing jointly or qualifying widow(er): $183,000 and above
- Single, head of household, married filing separately and did not live with spouse anytime during 2012: $125,000 and above
- Married filing separately and lived with spouse anytime during the year and your MAGI is above 0: $10,000 and above
TAX: The ultimate difference and the main factor that can helps many, including you, to decide between a Roth vs. a Traditional IRA is tax. The time when tax benefits are granted vary between the two.
Traditional IRA is tax-deductible while you are making your contributions while Roth IRA grants tax-free distributions.
RESTRICTIONS AND PENALTIES:
(Related article: 401(k) Is Not Enough: 4 Alternatives to Your Retirement Planning)
Restrictions apply to both a Roth IRA and a Traditional IRA, but they vary with regards to when it is imposed. The Traditional IRA imposes restrictions on how much contribution can be deducted from your tax while Roth IRA imposes restrictions on how much you can contribute based on your MAGI.
Penalties are imposed on those who contribute to Traditional IRA and would like to make early withdrawals before they are aged 59½. Distributions taken from contributions are allowed in a Roth IRA five years after the first contribution was made without any early withdrawal penalty.
DISTRIBUTIONS: As mentioned, Roth IRA distributions are tax-free while Traditional IRA distributions are taxable because they are treated as ordinary income. With a Roth IRA there are no mandatory withdrawals, but with a Traditional IRA mandatory withdrawals are required for contributors when they reach the age of 70 ½ or they are subjected to a 50% excise tax on the required amount not withdrawn.
If you are at the planning stage of your retirement, always keep in mind that ample research is beneficial. You should look at all the angles to see which type suit your needs. Whichever is best between a Roth vs. a Traditional IRA, you need to consider that your choice should suit your needs.
It’s never too early to plan for your retirement. Have you designed your future yet? Do you already have a retirement plan in place? What is it, and do you like it?Authorbio: Dominique Brown of YourFinancesSimplified.com wrote this article. Subscribe to his blog and his video blog! He gives great financial tips!
My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.