Since the conception of the Individual Retirement Arrangement (IRA) in 1974 from the Employment Retirement Income Security Act (ERISA), it has helped thousands of individuals to save money for a comfortable retirement. Over the years, the types of IRAs have evolved and increased in number.
Although, this gave contributors more options to choose from, in some ways, it made it hard for some to select which one to use right away. The types of IRA available are SEP IRA, Simple IRA, Self-directed IRA, and the two most popular types: Roth IRAs and Traditional IRAs.
How well do you know your IRA?
Whether you already have a type of IRA in mind or in the process of choosing one, it is important to know the facts behind each type. The background and particulars of both Roth and Traditional IRAs, two of the most popular types of IRA available, are significant and learning about them will help you to see which one is more applicable to you and your current status.
Roth IRA was created through the Taxpayer Relief Act of 1997. It was named after the late Senator William Roth, its legislative sponsor. The main objective of the introduction of Roth IRA was to relieve some restrictions of the other forms of IRA. Contributions to Roth IRA are not tax-deductible, but it does feature tax-free distributions.
Over the years, the Roth IRA became popular because of its flexible options of age limit and penalty-free early withdrawals.
The mechanism behind the Roth IRA is much like the other types of IRAs except that its contributions are not tax-free. The distributions however are not subject to tax. When it comes to eligibility, it is not age dependent. Anyone can contribute if the age is the factor to consider. With regards to income, your eligibility to invest in a Roth IRA may be restricted because there are certain income limits that you must not exceed in order for you to be qualified to apply for a Roth IRA.
One of its best features is that even after you reach 70½ yrs. old, you can still contribute continuously and no forced withdrawals are required as opposed to other types of IRAs.
This unique feature is best enjoyed by individuals whose goal is to save. You can keep your money in the account for as long as you like and withdraw it anytime you need it.
Traditional IRA (also called ordinary or regular IRA) came to existence through the Tax Reform Act of 1986. It is the oldest type of IRA and has been an effective retirement savings tool for nearly a quarter of a century. It was originally created in 1975 but huge reforms were made in 1986.
It was originally defined by the IRS as “any IRA that is not a Roth or a simple IRA.”
The top feature of Traditional IRA is its contributions are tax-deductible. The amount to be deducted (full or partial) is limited and dependent on your status. Whether or not you and/or your spouse are covered by a retirement plan at work affects your eligibility to receive tax-benefits.
Eligibility to set-up an account is not measured by the income you earn. Anyone who has income is welcome to contribute to a traditional IRA, but is applicable only up to the age of 70½. After this age, you are not eligible to contribute anymore and the distributions are mandatory. It means that whether you like or not, you need to withdraw your money regularly.
No early withdrawals are also allowed without paying a penalty of 10%. Although you may enjoy tax benefits while you are still paying your contributions, future distributions, however, are considered income and are subject to tax.
ROTH vs. TRADITIONAL IRA: Which one is more flexible?
When looking at flexibility when considering Roth IRAs vs. Traditional IRAs, the Roth IRA is deemed to be more flexible. You can withdraw or deposit your money anytime without the burden of penalties, and there no mandatory withdrawals if you still want to continue to keep your money in the account.
If you want to enjoy tax-deductible contributions then Traditional IRA is the best choice, but if saving for the future and enjoying tax-free withdrawals appeal to you more then go with Roth IRA.
Perhaps the more fitting question to compare easily Roth IRAs vs. Traditional IRAs is “Do you want to pay taxes now or in the future?”
Call to action.
Leave a comment specifying which IRA you have and why you choose that type of IRA.