It is extremely important to start young with your retirement planning and IRAs are one of the best ways to start. IRA stands for Individual Retirement Account. IRAs are separate from employer sponsored retirement accounts. If you do have an employer sponsored retirement, it is smart to have an IRA account as well to maximize your retirement savings options. There are two types of IRAs, traditional and Roth. Continue reading to learn the difference between a traditional IRA and a Roth IRA.
A traditional IRA may allow you to make pre-tax contributions. These accounts are best suited for someone who expects to be in the same or lower tax bracket when they start withdrawing from the account. The account contributions grow tax deferred. Traditional IRAs give you immediate tax benefits by being able to deduct a portion of your contribution from your taxes. Contributions can come from pre-tax or after-tax dollars. The maximum contribution for 2021 is $6,000 but it is $7,000 if you are over the age of 50 because of the “Catch up” contribution. Anyone with earned income can contribute to a traditional IRA without age restriction. As for withdrawals, there are no penalties, but it is taxed as current income after 59 & ½. There is a mandatory distribution policy for the age of 72.
A Roth IRA allows the account holder to make after-tax contributions. These accounts are best for an individual who expects to be in a higher tax bracket when they start taking withdrawals. Contributions grow tax free inside of a Roth IRA. The contributions come from after-tax dollars. The max contribution for 2021 is $6,000 but it is $7,000 if you are over the age of 50 because of the “Catch up” contribution. People with earned income below a certain level are eligible to contribute. There is not an age restriction for contributions. Withdrawals are penalty free and tax free after 5 years and after age 59 & ½,
One extra benefit of the traditional IRA is that you can withdraw up to $10,000 penalty free to cover first-time home buyer expenses. This is extremely helpful for people who started their IRA account at a young age. Both traditional and Roth IRAs have qualified education and hardship withdrawals available.
The biggest difference between traditional and Roth IRAs is whether you want to take advantage of the tax advantages now or have tax-free withdrawals later. The main factor for consideration on which type of IRA you should choose is what you expect your future income and tax bracket will be. Determining if the tax rate that you will pay on your Roth IRA contributions now will be higher or lower than the tax rate you will pay on distributions of your traditional IRA later on is an important item to consider.
Both IRAs are a great option for retirement savings, each offering their own tax benefits. If you are looking for advice on which IRA is best for you, LifeBridge Financial is here to help!
Sources:
https://www.investopedia.com/retirement/roth-vs-traditional-ira-which-is-right-for-you/
https://www.schwab.com/ira/understand-iras/roth-vs-trad-ira