When making decisions about your financial future, it can be confusing and frustrating trying to understand the ins and outs of financial planning for retirement. Many people can’t afford to make a money mistake. Understanding IRA’s may be one of the more difficult aspects of planning for retirement savings goals. But gaining the knowledge of which IRA may be better for you, the Traditional IRA or the Roth IRA, can help to improve your money in the future.
Traditional IRA
First off, IRA stands for Individual Retirement Accounts. They are designed by the federal government. The Traditional IRA was first established in 1981 to help American citizens with a way to save for retirement through a means that is tax beneficial. Taxpayers are able to contribute a yearly total of $5000 or $6,000 (over 50 years old) into an account. The contributions are tax deductible and earnings on the account are then tax-deferred until the account holder reaches the age of 59 ½.
Roth IRA
The Roth IRA is a more recent venture, established in 1998 is not an option to individuals who have a gross yearly income of $110,000 for singles and $160,000 for married people. Also with the Roth IRA, the contributions are not tax-deductible in the year they were made. However, the money contributed and distributed from a Roth account is tax-free during the lifetime of the account.
Deciding which kind of IRA is the right one for you will ultimately be a personal decision. Each person may have their own opinion about which to choose so individuals are best to decide for themselves or upon the advice of a financial advisor. Many feel that the Roth IRA is the best choice because in the long run all the money in the account will be tax-free for life (provided laws remain the same), even if the contributions are not during the working years. If you meet the financial guidelines, the Roth can be viewed as having the more valuable option. Some individuals feel that they prefer the tax-deduction benefits during the working years through the Traditional IRA. Concern about the changing of laws in the future years is relevant because of the country’s growing deficits.
Making the Change
Some individuals will first choose one type of account over the other but then down the road change their minds. Regardless of which account you started first, you can make the switch. You can do what is called a ‘rollover’. While a rollover is possible, it doesn’t come without a cost. You will be required to pay taxes at ordinary rates on the amount transferred but you are not required to pay penalty fees for early distribution. Making the decision to rollover funds will require that you look at the end result and if the hit you took in taxes early will be less than what you would have spent in the long term. For instance, if an individual 35 or younger were to convert from a Traditional to a Roth account, the move would likely be smart and ultimately pay for itself but not work from those older than 35.