When planning to save for your retirement, you have a number of options on where you can invest your money in order for it to grow. Many financial planners advise that clients take out an Individual Retirement Account (IRA) when they sit down to do their estate planning. An IRA is like opening a savings account, but this provides you with tax breaks which is an ideal situation when you want to save a considerably large amount of money for your retirement.
Once you have decided to get an IRA, you have to decide whether to get a traditional IRA or a Roth IRA. It is very important to decide which type you should take out and be able to select that best one for your unique situation because the type of IRA that you will pick out now will ultimately affect you as well as your family’s savings.
Tax treatment
Although both types provide you with generous tax breaks, the major difference between a Roth IRA and a Traditional IRA is the point when taxes is applied. With traditional IRA, you pay taxes when you are already withdrawing the money from the account. With Roth IRA, the taxes are applied in the front end once you put money into the account. So when you want to avoid tax when putting the money in, choose traditional IRA and get Roth IRA when you want to avoid paying tax when you take the money out for your retirement.
When it comes to distributions, the distributions that you receive from a traditional IRA is treated like ordinary income and is always subject to tax. On the other hand, distributions qualified under the Roth IRA are penalty and tax free if they meet the requirements.
Limits in income
Individual Retirement Accounts have restrictions when it comes to income qualifications as well as employment status. With Traditional IRA, anyone with an earned income can be eligible to apply for one so long as you apply before the age of 70 ½. With Roth IRA, there are stricter qualifications and you are only qualified to apply if you have taxable compensation that falls below certain amounts.
Withdrawal of funds
The difference between the rules regarding the withdrawal of your savings between the two types of IRAs must be considered before you decide on starting with your IRA. Roth IRAs can be more flexible when you intend to withdraw some portion of your savings early. Roth contributions can be withdrawn even before you turn 59 ½ without any penalties and tax charges.
However, when you intend to leave your money to grow and have no use for it, getting a traditional IRA may not be the best choice for you since you will be required to start to withdraw a certain amount from the account once you reach the age of 70 ½. If in case you decide to withdraw your savings before you reach the age of 59 ½, the amount will be subject to early distribution penalties.