By Cesar Mejia-Duenas
“The plans of the diligent lead surely to abundance, but everyone who is hasty comes only to poverty.” (Proverbs 21:5)
It is not surprising that saving and investment decisions have always been a part of our lives. For this reason, we are called to learn about the different investment vehicles we might use to maximize our savings for retirement. In this article, we explain some of the differences between traditional IRAs and Roth IRAs.
The term IRA stands for Individual Retirement Account. Financial institutions provide for IRAs that allow you to make tax-advantaged contributions to save for retirement.
There are several types of IRAs. However, the most common are the traditional IRA and the Roth IRA. It is essential to understand the differences between these accounts because selecting the type of account might have significant consequences on your retirement funds.
Some of the major differences between the traditional and Roth IRAs are: (i) the moment when contributions are taxed, and (ii) the withdrawal rules.
First, for the traditional IRA, contributions are not taxed up front. Furthermore, these contributions can be fully or partially deductible from your income, depending on your circumstances. On the other hand, in a Roth IRA, contributions are taxed upfront at the moment they are made. Thus, the amount in the account grows tax-free. However, the contributions made to the Roth IRA are not deductible.
Second, both traditional and Roth IRAs have different withdrawals rules. For the traditional IRA, the account holder is required to make annual withdrawals from the account at age 70 ½. This rule can be an important decision for senior investors who are seeking to make their retirement grow or to conserve their capital. To the contrary, Roth IRAs don’t require any withdrawals during the owner’s lifetime. Thus, if the owner does not need the income from the Roth IRA, the account can continue to grow tax-free even after the owner reaches the age of 70 ½.
It is important to point out that for the traditional IRA, withdrawals are penalty-free beginning at age 59 ½. For the Roth IRA, the withdrawal rules vary. Contributions can be withdrawn at any time tax-free because the taxes were paid in advance. However, the earnings can be withdrawn penalty-free only after the account has been open for five years, and the person has reached the age of 59 ½.
Finally, we recommend that you visit your accountant to evaluate what account would be best for your particular situation. Also, remember that the number one factor in determining how much you will have at retirement is the consistency in which you make contributions to your account. Plan in advance, and plan for abundance.