Tahoe-Truckee Market Beat: What’s the difference between a Roth and traditional IRA?
Now that tax time is upon us it may be time to consider establishing an IRA or making a contribution to an existing account.
You can still make an IRA contribution up to April 15th or until the time you file your taxes. Traditional IRAs and Roth IRAs differ in their tax treatment.
Contributions to a traditional IRA are tax deductible and will lower your AGI, adjusted gross income. Roth contributions are not tax deductible.
So, if you’ve estimated your taxes for this year and it looks like you may have a tax liability, contributions to a traditional IRA could lower your taxes. If you don’t have much tax due, a Roth might make more sense.
Withdrawals are treated differently, too. Withdrawals from the traditional IRA are subject to income tax and withdrawals from a Roth are not. Both types of accounts allow for tax deferred growth of your funds.
The contribution limits are the same for either account. The maximum amount you can contribute is $5,500 or $6,500 if you’re over the ripe old age of 50 for the tax year 2015.
Traditional IRAs are subject to mandatory distributions which must begin at age 70 ½, while Roth IRAs are not subject to mandatory distribution rules, so you can leave the funds in a tax deferred account as long as you want.
Roth’s make for excellent wealth transfer vehicles to beneficiaries because of the mandatory distribution rules.
Typically the Roth is better for younger people who don’t need much of a tax deduction in the current tax year. There are numerous calculators available online that you can use to see which one might be best for your individual situation.
If you do want to save for retirement, is helps a lot to start early and give your funds time to compound. According to an example on the Fidelity website, a person who starts at age 25 and contributes $5,500 per year for ten years and then stops will have more money at age 65 than someone who starts at age 35 and contributes $5,500 per year for thirty years.
They assumed an average growth rate of 7% for that example. The person who started at age 25 and put in a total of $55,000 over ten years would see his or her account grow to $618,951 at age 65. The person who started at 35 and contributed $165,000 would have $555,902 at the same age.
Remember, save early and save often.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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