There are several types of IRAs (Individual Retirement Accounts) available when planning for retirement. The main ones include Traditional and Roth IRAs. It is normally puzzling to choose between the two but with sufficient explanation, you can be able to decide the best option for your case.
Traditional IRA
Traditional IRAs go under different names but encompass the same principles. All contributions made to the Traditional IRA are tax deductible according to how much you earn. Meaning, the money deposited in the account is not subject to taxation but with conditions attached. Any earnings accrued on your contributions are not subject to taxation until you withdraw the money upon retirement. For instance, if you make $50,000 annually and deposit $3000 in the account, you will only pay taxes on $47,000. Your deposit will earn interest and grow tax free throughout the years. The money will be taxed after you hit retirement age and start withdrawing from the account. You can estimate the potential benefits you stand to make using a standard Roth IRA calculator.
You may choose a Traditional account if you feel like your current tax rates are high and might significantly affect your contributions. Given you will have deposited enough in the account; you will achieve substantial savings in tax rates in the long run.
It is also possible to make several investments with the money so long as it remains untouched in the Traditional account. Deposits will remain tax-free but your normal accounts will still be liable for taxation. Contributions to Traditional IRA Accounts can only be withdrawn when you retire between the ages of 59 ½ and 70 ½ yrs. Any earlier withdrawals are subject to income tax and a 10% penalty on interest accrued. You will however be given a number of circumstances under which you can withdraw the money and have the penalty wavered.
Roth IRA
Contributions made in to a Roth IRA are subject to upfront taxation. Meaning, any deposits made in to the retirement account are subject to income tax. Working with the above example, you will be taxed for both the $47,000 and the $3,000 in your accounts. The figures may vary depending on your earnings and a Roth IRA calculator can give you figures for your exact income level. When you finally withdraw the money from the account, it is tax free including all the income accrued over the years. Of course this is assuming you have attained the stipulated retirement age of 59 ½ and have been contributing to the account for a period of more than five years.
The difference between Traditional and Roth accounts is the taxation conditions. The former option offers you tax exemption but will ultimately charge you for the savings and benefits gained during the years. The latter option offers you tax inclusion but will ultimately defer your taxes when you reach retirement age.
Most people who choose the Roth option are mostly concerned about rising rates of taxation. By taking up this option, you can pay taxes presently and avoid raised rates in future.
The choice between the two options can be quite confusing at the beginning. It is recommended you sit down with an accountant or other financial or tax consultant to weigh your options. They will crunch the numbers for you using a Roth IRA calculator and depending on other factors such as your net income and state of residence; you can decide in the best option.
