If an Individual Retirement Account (IRA) is right for you, which one should you choose – a Roth IRA or a Traditional IRA? You would think the answer is simple. But this is about taxes and income.
In both a Roth IRA and Traditional IRA, the money you contribute has the potential to grow income tax-free. But there are several big differences between a Roth IRA and a Traditional IRA that may affect which one you decide to use.
- You pay taxes when you take the money out. Depending on your income and other factors, you might not pay taxes on the money you put in.
- You cannot make contributions after age 70½.
- You must begin withdrawing money at age 70½.
- There are no income restrictions to participate.
- You put in money you have paid taxes on for that year. So the money you take out later has the potential be income tax-free.
- You can make contributions at any age as long as you have earned income.
- You never have to withdraw any money from your Roth. So you can even leave it to your heirs who can make tax-free withdrawals (but they may have to pay estate taxes).
- There is a participation limit based on your income.
Both plans have some things in common:
- You will have to pay a 10% early withdrawal penalty if you make withdrawals before age 59½ unless an IRS exception applies. You must hold your Roth IRA account for five years before making withdrawals or the earnings will be taxed in addition to the IRS penalty. A Traditional IRA requires you to pay income tax on withdrawn earnings and contributions.
- You have until Tax Day of the next year to fund your account for the previous year.
- In 2016, if you have earned income from W‐2’s or business income, you can put up to $5,500 a year in either plan. If you participate in your employer’s retirement plan or you make contributions on behalf of your non‐working spouse, a Traditional IRA may have income requirements that determine whether or not you can deduct contributions from your taxable income. The specific requirements can be found here.
Which IRA you choose boils down to whether you want to pay taxes on the contribution you make today (Roth IRA) or wait until you retire and pay taxes on your withdrawal (Traditional IRA).
- If you think you will be in a lower tax bracket when you retire, consider a Traditional IRA (if you are in a high income bracket now, you may have no choice but to select a Traditional IRA).
- If you want to pay the income taxes on your contribution today, and let it have the potential to for tax-free qualified withdrawals later, pick a Roth.
- For maximum tax-planning flexibility, you may want to think about investing in both.
The tax information herein is not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding tax penalties. Taxpayers should seek advice based on their own particular circumstances from an independent tax advisor.
Securities and investment advisory services offered through Voya Financial Advisors, Inc. member SIPC.
Neither Voya nor its affiliated companies provide tax or legal advice. Please consult with your tax and legal advisors regarding your individual situation.