Why would you want an IRA? Retirement, right?
Roth or Traditional?
What’s the difference?
Would you rather a tax credit now or pay no taxes later?
When will you need the money?
Maybe you want both…
There are significant differences between an IRA and a Roth IRA. They all center around taxes. Most people start thinking about this when they need to rollover an existing 401k and will not have a choice. In this sense, you must use a Traditional IRA, and here’s the reason why. A 401k allows you to contribute to it before taxes. Once you are eligible to take the money out at age 59.5, the money is taxed at your tax bracket rate.
This is when most folks start thinking about it, but you should actually think about it much sooner.
Keep in mind at age 59.5 is when you are allowed to take money out without penalty. Once you reach age 70.5, you must start taking what’s called RMDs or Required Minimum Distributions. Did you know that you are able to contribute to the IRA outside of a 401k rollover. Once you contribute to the IRA, since your money has already been taxed, you get a tax decution torwards that tax year. This can be prove to be quite a nice perk for federal and state income taxes.
The Roth IRA has a unique difference. The difference about the Roth IRA is that it grows tax free like the IRA, but the withdrawals won’t be taxed later on like the IRA. This is the reason I would encourage everyone to have a Roth IRA. Similar to the IRA, folks don’t have to start taking the money out until age 70.5. Let me emphasize that when you do take out the money, there are NO TAXES, but you must wait until age 70.5. Since there is no tax credit when the money is contributed, it means a bonus of not paying taxes on the way out. This is a great strategy for those looking to contribute more funds outside of the 401k plan for retirement with additional income for things that matter. Like having a place by the water.
I know this decision seems so far down the road, but the best way is to actually use both strategies. This way you can enjoy a tax deduction now using the IRA, and withdraw money later without tax penalty. How much money are you allowed to contribute? Good question. Before getting to that, it actually solely depends on how much you make today.
How much money do you make? How do you file your taxes? Well, the ability to contribute also depends if filing single or jointly. Singles that are head of household can contribute if they make under $127,000 annually. Make more than this, don’t even try. Instead, focus on your 401k plan at work to max out contributions of $19,500 annually. What about married couples? I thought you’d never ask. If jointly, it’s over $188,000. Eligibility to contribute to an IRA is lost because the IRS says. It’s that simple. Keep in mind the option to max out the 401k at $19,500 per year.
Contribution limits? If you are under the age of 55, contributions up to $5,500 per tax year are allowed (including January – April for prior year contributions). What does this mean? Let’s say in 2015, you contribute $4,300 for the entire year and still have the ability to contribute $700 more. This means in 2016, you can contribute that $700 up until the tax deadline in April as prior year contributions. It’s a great advantage. Now, if you are over the age of 50, folks have the ability to contribute “catch-up” contributions of $1,000 up until 59.5. This is to help those who are behind on their retirement savings.
At the end of the day, the contribution decision for a traditional or Roth IRA ultimately depends on your anticipated income later in retirement. Regardless of which choice is best for your situation, either are good options. Both options will help set you up for retirement later in life.
Alex Richwagen is an investment research analyst. Any of his recommendations are that of Mr. Richwagen, the information presented by him is the opinion of his research. All investment decisions are your choice and should be based on your own analysis.