It is never too early to start planning for your future retirement. According to financial experts, you should expect to spend 55%-80% of your current income annually in retirement. To have enough funds to enjoy the later part of your life, we suggest that our clients consider investment retirement accounts (IRAs). There are two main types of IRA accounts—Roth and traditional- and each has its pros and cons.
What is a Traditional IRA?
A traditional IRA allows individuals to save income before it gets taxed by the government. In other words, you do not pay any taxes on money saved in a traditional IRA until you make a withdrawal. Funds can be withdrawn starting at age 59.5.
Once you reach the age of 72, you must make the required minimum distributions (RMDs) to your account. And, depending on your tax status, you may be able to deduct the contributions partially or fully you make to your traditional IRA when filing your taxes.
What is a Roth IRA?
In contrast, with a Roth IRA, the government taxes money placed into it upfront. This means that withdrawals are tax-free. Funds can remain in a Roth IRA forever—there are no required minimum distributions to take. In addition, Roth IRA funds can be withdrawn at any time, for any reason—you do not have to wait until a certain age to make a withdrawal. However, taxes may be applied to any interest from funds that you withdraw. And, if it’s been less than five years since you started contributing to your Roth IRA, you might face a withdrawal penalty.
Which IRA is better for me?
Both traditional and Roth IRAs are solid choices when saving for retirement. However, there are enough differences between them to make one option better than the other, depending on your lifestyle and financial situation.
Regardless of which IRA you choose, it’s important to note both have the same annual contribution. In 2022, a person under the age of 50 can contribute up to $6,000 per year. The amount increases to $7,000 per year for those ages 50 and older.
Consider the following to help you figure out which type of IRA will work best for you.
1: Are You Filing Married or Single?
While anyone at any income level can participate in a traditional IRA, there are income limits to a Roth IRA. A person filing their income taxes as single can only contribute to a Roth IRA if they earn less than $140,000 in 2021 and $144,000 in 2022. And a married couple filing jointly may participate in a Roth IRA if their combined income is less than $208,000 in 2021 and $214,000 in 2022.
2: Will You Need to Withdraw Funds Early?
As we outlined earlier, you cannot touch traditional IRA funds until age 59.5 without penalties. However, if you think you may need access to that money earlier, a Roth IRA will make more sense for you.
3: Will Your Future Tax Bracket Change?
When deciding between a Roth vs traditional IRA, you’ll need to consider tax bracket you expect to be in at retirement. If you believe you will be in a higher tax bracket, a Roth IRA allows you to pay taxes now so that withdrawals are tax-free later. However, if you believe you will be at a lower tax bracket after retirement, a traditional IRA might be your best option, as the taxes you pay on withdrawn funds will be lower than the taxes you would pay on deposit.
At the end of the day, whether you choose a Roth or traditional IRA, you will be setting yourself up for economic stability later in life. If you have more questions on Roth vs
traditional IRAs and how they play a part in the estate planning process, contact Scarola Law today.