Is an IRA an option worth considering for you? If so, which is better?
A Traditional IRA is an individual savings account that allows you to contribute money for your retirement. Depending on your income level, you may deduct the contributions from your taxable income. Any earnings made in a Traditional IRA account remain tax-deferred until the money is withdrawn from the account. Tax is only paid on the money once it is withdrawn. After the account holder reaches age 70 1/2 you may no longer make contributions into your Traditional IRA and minimum required distributions must be taken from the account each year. Anyone with earned income can create a Traditional IRA, but if you also have a retirement account with an employer, there are income limits to the amount you can contribute to your IRA in pre-tax dollars.
A Roth IRA is an individual retirement account that allows you to contribute income that has already been taxed (“after-tax” dollars). Withdrawals of earnings on contributions from Roth IRA accounts are federal income tax-free so long as a 5-year holding period has been met and the account holder is at least 59 1/2 years old, disabled, or deceased. Withdrawals of contributions are always tax-free since you already paid the tax on the contributions. There are no required minimum distributions nor are there age limits for contributions.
- Traditional IRA contributions that qualify for pre-tax treatment will allow a larger beginning investment to compound over time versus a Roth IRA.
- Roth IRA contributions, though smaller because of tax treatment, could create earnings that are never taxed.
- Roth IRA accounts have more flexible contribution and withdrawal rules.
So the answer is. . .it all depends. If you think tax rates will be significantly higher when you withdraw your retirement savings, then think seriously about a Roth IRA.
If you think your retirement account investments will perform well, then perhaps the earnings growth in a Traditional IRA will more than pay for the additional tax at time of withdrawal.