Planning For Retirement: Roth Ira’S

There are many different types of Individual Retirement Accounts (or IRA’s) to choose from when you are planning your retirement strategy but there are only two basic categories: the traditional IRA and the Roth IRA.

 

The Roth IRA differs from the traditional IRA in many respects. First, let’s start with the similarities. Each plan can be set up by an individual to fund retirement. Both have the same contribution limits (currently $4,000 per year or $5,000 if you are 50 or older). The investments grow tax-free while invested. The main differences occur on the tax consequences of the contributions and withdrawals. It is these differences that make the Roth IRA a popular first choice before a traditional IRA.

 

In a traditional IRA, contributions are deductible from current income. But, when contributions and income are withdrawn at retirement, both are taxable as ordinary income. This has the effect of deferring tax on the contributions and income and creating a potential permanent tax savings if you are in a lower tax bracket at retirement. However, the income is taxed the same way regardless of whether it is derived from capital gains, dividends, or interest.

 

In a Roth IRA, there is no deduction of the contributions, meaning that they represent “after-tax” funds. Withdrawals of contributions (not income) can be made from the plan at any time without tax or a penalty, which gives more flexibility to accommodate changes in financial needs over time. When contributions and income are withdrawn at retirement, they are tax-free, meaning that you never pay the tax on the income in a Roth IRA. That’s a permanent tax savings.

 

Of course, there are some rules, limits, and restrictions on both the traditional and Roth IRA’s. Both plans should feature prominently in your retirement planning. Investors can have both plans in force to maximize contribution limits.

 

Taking advantage of tax-deferred IRA plans is a smart way to accumulate wealth for the majority of Americans. Knowing the tax rules that relate to each type of plan ensures that you minimize tax and make the most out of your retirement.