Today young workers are encouraged to start savings and asset building strategies as early as possible. A valuable asset to most individuals is their retirement account. A common question is whether to choose a traditional (tax-deferred) or a Roth option.
Many people who prefer a Roth IRA say that paying taxes on retirement contributions today is better than paying taxes on retirement savings tomorrow. While traditional IRAs have been around since 1974, the Roth was created more recently in 1997. Here are some of its benefits:
1. After-tax Contributions
Taxes have already been paid on the money that you invest. In exchange for paying taxes on your retirement savings contributions today, you could potentially realize greater benefits tomorrow.
2. Tax-deferred Growth
Your earnings on the Roth individual retirement account aren't taxed as they grow and compound. The earlier in life that you open a Roth, the greater asset building potential you have.
3. Tax-free Retirement Income
Earnings on a Roth can be withdrawn tax-free as long as you are age 59½ or older and have owned the IRA for at least five tax years. These tax-free withdrawals, or qualified distributions, can be made to you during your lifetime or to a beneficiary after you die.
4. Annual Contribution Limit
The 2018 contribution limit is $5,500, with an additional $1,000 “catch-up” contribution allowed if you are 50 or older. (For those who own more than one, that $5,500 limit applies across all your IRAs.) You can keep making annual Roth IRA contributions all your life. You have to stop making contributions to a traditional IRA once you reach age 70½.
Roth IRA’s do have some limitations.
1. Early Withdrawal Penalty
Withdraws made from Roth IRA funds before age 59½ or from an IRA that you have not owned for at least five years, are subject to a 10% penalty by the IRS. You would also pay income tax on funds withdrawn early.
2. No Tax Deduction
Unlike the traditional IRA, contributions to a Roth are not eligible for tax deductions on your 1040.
3. Income Eligibility
If your income is too high, you may not be eligible to contribute to a Roth or may be limited to a partial contribution. Consult your accountant to decide whether you qualify for a Roth individual retirement account.
There are many variables to consider when choosing your retirement plan options. A smart strategy is to consult your CPA or financial advisor. The professional will look over your income and the projected tax rates to determine which option would benefit you.
Charles P Myrick CPA offers tax preparation services for individuals using a process that combines smart, personalized planning with annual tax preparation and filing. Our job is to help you know about all the available tax opportunities that meet your individual needs and circumstances. We work closely with tax lawyers, and investment advisors to ensure that all the details are legally sound, technically accurate, and working to your maximum benefit. Contact us to learn more: (202) 789-8898