Roth vs. Traditional IRA Accounts

For our first official blog post we are going to start with something that is so important: retirement planning, specifically Roth vs. Traditional Individual Retirement Accounts (IRA’s).

First and foremost, whatever type of account suits you best, start investing in retirement as early as possible. 

So let’s get started.  The primary difference between Roth and Traditional IRA’s are the tax implications.  With a Roth account, you will pay taxes on the money before it is invested and no taxes upon withdrawal.  In a traditional account, you invest tax free money but you are taxed upon withdrawal.  The amount you contribute to a traditional account will also reduce your taxable income for that year.

Here are some facts that these accounts have in common. Both have a maximum yearly contribution of $5,500 (for 2013 & 2014) if you are under the age of 50 - $6,500 if you are over 50.  There are very few situations in which you can withdraw from your retirement account without paying a 10% penalty:

1. You are at least 59 ½, woo hoo! Bring on the retirement money!
2. You are using this money for a down payment on your first home (maximum withdrawal of $10K).
3. You are disabled in one way or another and need the funds to cover expenses.
4. You are using the money to pay college tuition for someone in your immediate family.

So which on is better?  The answer is…. they are both great retirement savings tools.

Although contributions to a Roth account don’t help reduce your taxable income in the current year, you don’t have to pay any taxes upon withdrawal.  So… that means that all of your earnings are tax free.  That is a great tax break since any other money that is invested is subject to Capital Gains Tax.  Also, say you’re currently in the 25% tax bracket, and when you retire you’re in the 35% tax bracket; if you invested in a Roth account you just saved 10% on that money. 

Even though you don’t save the tax money on the withdrawal side with a traditional IRA, there are different benefits to this type of account.  Since you don’t pay taxes on the money up front, you are investing a larger sum.  This larger initial contribution of money will grow over the years to retirement and your account will be larger due to compounding growth effects.  When you do withdraw from this account, you will pay taxes on the income.  Additionally, there is a tax benefit you will realize upon investing in your traditional IRA.  Say your annual salary is $50,000, you invest $5,000 pre-tax into your IRA and you are taxed in the 25% bracket.  Your taxable income after your retirement investment becomes $45,000, which saves you an estimated $1,250 in taxes.  

Aside from these taxable implications, there are additional differences. 

•           Roth accounts have an income cap – if you make over $167K (married) or $105K (unmarried) you can no longer contribute to a Roth.  
•           Traditional IRA’s require minimum withdrawals by April 1^st after the age 70 ½. Roth accounts do not require minimum distributions.

If you invest the same amount of pretax money into both types of accounts and your tax bracket never changes, upon withdrawal the amount of money would be the exactly the same. 

Both types of accounts have their benefits.  We recommend looking at your personal finances and deciding which is best for your situation.  Our strategy for retirement is to invest in both types of retirement accounts, what is your strategy?

Check out this Roth vs. Traditional IRA calculator to see the potential of your retirement account!

http://www.bankrate.com/calculators/retirement/roth-traditional-ira-calculator.aspx