Should You Use a Traditional or Roth IRA?
Since their inception in 1974, Individual Retirement Accounts, or IRAs, have become wildly popular. About 42 million US households, or 30%, owned at least one type of IRA as of mid-2014. By the end of that year, IRA assets totaled $7.4 trillion, which was about 30% of US retirement assets.1
People like IRAs because they can be invested in just about everything except life insurance or collectibles, so there are many options for putting your money to work. Investors with experience in real estate can even use their money to buy property through a self-directed IRA.
Unlike employer-sponsored retirement plans, with an IRA, you are the complete owner and the plan is in no way tied to your employment. You can even withdraw money penalty-free before age 59 ½ if it is for a qualified first-time home purchase or education expenses.
For many people, investing in an IRA is an easy decision. Where they struggle is in deciding which kind to invest in, a traditional or a Roth.
Benefits Of Investing In a Traditional IRA
Prior to 1997, there was only one kind of IRA, which is now referred to as a Traditional IRA. It is a tax-deferred retirement account, meaning that is funded with pre-tax money and the taxes are paid when the money is withdrawn during retirement.
This is a great benefit because you have more money available to invest if you don’t have to pay taxes first. Also, people often find themselves in lower tax brackets in retirement, so you may pay less in taxes than you would otherwise. The tax deduction for a Traditional IRA may be limited if you or your spouse are covered by a retirement plan at work and your income exceeds certain levels.
Benefits Of Investing In A Roth IRA
Out of the Taxpayer Relief Act of 1997 a new kind of IRA was born, named after Senator William Roth of Delaware who was the chief legislative sponsor of the act. Roth IRAs differ from traditional IRA’s in a few key ways. The biggest difference is the tax treatment. Whereas traditional IRAs are tax-deferred, with a Roth you pay all taxes upfront. The thing that makes Roths so popular, though, is that you don’t have to pay taxes on any of the growth. Everything generated by growth and compounding interest stays in your pocket.
Roths also differ from traditional IRAs in that there are no required minimum distributions during the account holder’s lifetime. So, you can leave your money in the account to grow for perpetuity, instead of being required to start taking withdrawals (and stop contributions) at age 70 ½, like with a traditional account. Some people even use this aspect of Roth IRAs as a way to provide tax-free income for their grandchildren and future generations. Another advantage is that contributions can be taken out at any time for any reason without penalty.
There are income limitations on who is allowed to use a Roth IRA. However, anyone can convert a traditional IRA into a Roth through a “backdoor conversion.”
Which Type Of Account Is Better For You?
Considering the differing tax treatment, a Roth IRA is almost always better for younger people who have more time to save and take advantage of long term growth and compounding interest. If you are nearing retirement and will need the money early in retirement, you may be better off with a traditional IRA. Many people choose a Roth regardless of their age so that they won’t be required to take distributions and they can leave the money to their families. If you make too much money to be eligible for a tax deduction for a traditional IRA you are better off with a Roth, though you will have to do a “backdoor” conversion to open one.
If you are rolling over an old 401(k) to open your IRA, your decision regarding the type of account to open will have considerable tax implications. You won’t have to pay any taxes to roll over a traditional 401(k) into a traditional IRA, but to roll it into a Roth you will have to pay taxes on the entire account. For this reason, in 2012, 87% of new traditional IRA accounts were opened by rollovers as opposed to only 11% of Roth accounts.
The best kind of IRA account for you to open depends on your unique situation and preferences. When making important financial decisions, it is always wise to talk to an experienced professional who can help you understand your options and the implications of different choices. To learn more, set a time so we can talk, or get out with us on one of our upcoming fishing trips, call 949-481-1807.
Meet Rick
Over a 25-year career in financial services, Rick has helped hundreds of business and personal clients meet their investment goals by developing risk-efficient portfolio management strategies. He holds degrees in Economics and Psychology from the University of California, Irvine.
The water is Rick's second home: He and his family have been fishing Southern California and Baja going on four generations. In the 1940s, his grandmother worked at the Cannery Restaurant in Newport Beach—when it was an actual Albacore cannery. In the 1950s, his father was on the crew that built two of the boats still in service at Dana Wharf Sportfishing.
To schedule a complimentary wealth consultation or to get a second opinion on your financial plan, contact Sportfishing Financial today. To learn more about Rick, visit his website and connect with him on Facebook. To ask a question or get our list of upcoming fishing trips, call 949-481-1807.
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