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An IRA Showdown: Traditional v. Roth

So, you want to start saving more for your retirement, but you’re not sure what type of IRA to start – traditional or Roth. Here’s the skinny on how they are alike and how they are different so you can decide which is right for you.

IRA stands for Individual Retirement Account. That means only one person can own it and its purpose is to save for retirement only – so, there are very specific rules for how and when you can contribute to it and withdraw from it.

What’s the same about Traditional and Roth IRAs?

  • You can contribute a maximum of $5,500 in 2016, as long you have at least that much in taxable income
  • All contributions for 2016 must be made prior to April 15, 2017
  • Individuals over 50 can contribute an additional $1,000 each year

What’s Different about Traditional vs. Roth IRAs?

  • Taxes: Contributions to Traditional IRAs are tax-deferred and can be deducted from taxable income in the year they are contributed. When you take out the distributions during retirement, then you will pay tax (as ordinary income) on contributions and growth. Roth IRA contributions are made with after-tax dollars, meaning you don’t get a tax deduction in the year you make the contribution. So when you take distributions, no taxes are owed as long as you wait until you are 59½.
  • Age restrictions: You can contribute to a Traditional IRA while you are working, up to age 70½. There are no age limits for contributing to a Roth, but you must be working/earning a wage.
  • Income limits: If you’re a high-income earner, i.e. you make more than $117,000 as a single filer or over $184,000 married filing jointly, you cannot contribute to a Roth IRA. However, you can contribute to a Traditional nondeductible IRA (meaning you do not take a tax deduction the year you contribute) and then convert it to a Roth to save on taxes when you withdraw from it.
  • Required minimum distributions: You must begin taking a required minimum distribution (RMD) from your Traditional IRA once you turn 70½. If you don’t, you may face stiff penalties. There are no required minimum distributions for the original owner of a Roth IRA.

Generally, if you will be in a lower tax bracket during retirement, a Traditional IRA can work for you, but nothing beats tax-free income like that from a Roth IRA.

Whichever type you choose, understand that most IRAs are self-managed, meaning you will choose how to invest your contributions. Depending on your goals and needs, these charts may help you decide which is better for you. If you don’t have much experience choosing funds, stocks or other assets for investing, you’ll want to find a trustworthy investment firm, bank or financial planner to help you. Your trusted accountant can help, too. At Team Holly CPA, we have a Certified Financial Planner who can help you with all things retirement. Contact us today for a free consultation.

The key to building that retirement nest egg, though, is to start as early as possible – even if it is a small amount each year. Albert Einstein may have been joking when he said “the most powerful force in the universe is compound interest,” but it sure is true for retirement accounts!

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