Understanding Roth and Traditional IRAs
When it comes to saving for your future, there is a confusing alphabet soup of retirement-investment options that can leave even a savvy business professional scratching his/her head. From 401k to Roth IRAs, options abound for you investing opportunities. In this post, we're going to focus on private retirement opportunities, specifically, the Roth and traditional IRAs. You'll learn about the key differences and find yourself better equipped to make an informed decision.
Roth IRAs and traditional IRAs are both private, individual retirement accounts you can choose to put your hard-earned money into. They sound alike, and seem similar, but they are actually very different. The type of IRA you select will significantly impact you and your family over the long run. For this reason, it is important to understand the difference between the two.
With a traditional IRA, anyone with earned income who is under the age of 70 can contribute to a retirement account, with no limits on contributions currently in place. On the other hand, a Roth IRA has income-eligibility restrictions, with no age restrictions. Anyone with employment compensation can contribute to a Roth. For example, single individuals must have a modified adjusted gross income (AGI) under $129,000 (as of 2012) to contribute to a Roth. Married couples contributing to the same Roth account must have a modified AGI under $191,000 in order to contribute. The maximum contribution amounts for 2014 and 2015 are $5,500 or 100% of employment compensation, whichever is less. If you are 50 or older, you can contribute a maximum of $6,500.
Impact on Income Taxes
Perhaps the biggest difference between traditional and Roth IRAs is noticeable in the tax incentives available to you. Both offer generous tax breaks, but when you realize those breaks is vastly different. A contribute to your traditional IRA is tax deductible on both your state and federal tax returns in the year you make the contribution. However, when you withdraw that money in the future, it will be taxed at current income tax rates.
A Roth IRA operates on an opposite schedule. You will not be able to claim tax breaks when you make a contribution to your Roth, but when you withdraw that money in the future, you won't have to pay any taxes on the funds. When deciding between the tax impact of each type of IRA, you'll need to examine your future income tax rate in retirement to determine if you think it will be higher or lower than what you currently pay.
Withdrawals and Distributions
Another critical difference between the two types of IRAs is the withdrawal schedule. With a traditional IRA, you must start taking the required minimum distribution (RMD) from your account at age 70 ½. Conversely, a Roth has no mandate for the withdrawal of funds from your account. If you don't need the money, it can continue to grow tax-free throughout your life. Your funds can be passed on to heirs following your passing, making it an ideal wealth-transfer option.
RMD amounts apply only to traditional IRAs, and the calculation of that figure can be confusing. The IRS offers additional information, but generally speaking, RMDs are calculated for any account by dividing the prior December 31 balance by a life expectancy factor as determined by the IRS.
Preparing Your 2014 Taxes
The deadline for filing taxes for the 2014 calendar year is just around the corner. If you haven't made a contribution to your traditional or Roth IRA yet, you still have time to make those contributions and enjoy tax breaks (or avoid them, depending on your IRA type). The deadline to make a contribution for 2014 is April 15, 2015. Talk to your financial advisor for more information about contributions to your IRAs.