You have probably heard of Roth IRA’s but might not know exactly what they entail and if they are right for you. What makes a Roth IRA different from a traditional IRA? I try to keep everything simple on this website so in an attempt to keep doing that, there is one thing that mainly separates them. It is when your money is taxed.
With a Roth IRA, your money that you invest is taxed now. With a regular IRA, your money is taxed when it is withdrawn. So, in the future, when you withdraw money from a Roth IRA, including profits, it is tax free. When you withdraw money from a regular IRA, you will be taxed.
The ultimate decision on which type of IRA is for you should be made after consulting a qualified accountant or financial advisor. The Loan Monkey website does not take the place of the need for this. You are already here though, so for entertainment purposed let’s take a look at a few things.
Why Might You Want To Be Taxed Now?
With a Roth IRA, you will be taxed now. There are a lot of reasons that this might make sense.
- If you expect to make much more money in the future. This could put you into a higher tax rate. By paying taxes now, you can pay them at a lower overall tax rate and save money.
- If you feel that you will make a considerable profit on your account, you might want to pay taxes now on the lesser investment money and not have to pay taxes on your earnings.
- If you expect your children to inherit your money and you do not want them to pay income taxes on the money. This can be a large tax savings for them, but they still may have to pay an estate tax.
- If you expect overall tax rates to increase in the future, you may feel it is better to pay taxes now. Many feel that taxes will increase in the future since tax rates have been low in recent history.
Why Might You Want To Be Taxed Later?
With a traditional IRA, you will be taxed when you withdraw money later. There are also many reasons that this might make sense.
- You need to lower your taxable income now to lower your tax rate or to qualify for tax credits. Tax credits can be particularly rewarding but hard to qualify for. They are much better than tax deductions. With a $2000 tax deduction, for example, your taxable income would be reduced by that amount. With $2000 tax credits, your tax obligation would be lowered by that amount.
- You feel that you will make less money in retirement and will therefore pay lower taxes in the future. This might be the case if you do not plan to work in retirement.
- You want to use the money saved from not paying taxes now to further increase your investments. If you feel your money is better invested and you will offset potential taxes in the future, this could be an option for you.
- You feel that your tax rate in the future will be less for any reason.
More Roth IRA & Traditional IRA Food For Thought
Before you make up your mind, here are some more things to think about.
Income Limits To Qualify
As of 2019, single tax payers can qualify for a Roth IRA with an modified adjusted gross income of under $137,000. If you file jointly, that number goes to $203,000. The modified adjusted gross income takes your regular adjusted gross income and adds back things like student loan interest.
For traditional IRA’s, anyone is eligible to make contributions. Tax deductibility will change as income increases however.
The Roth IRA 5 Year Rule
Since your money was already taxed, you can withdraw the contributions that you have made to your account at any time without a penalty. Earnings are another matter.
To withdraw earnings tax free, you have to be at least 59.5 years old AND you must have contributed to the account for the first time at least 5 years before you make a withdrawal.
With a traditional IRA, you are required to start taking minimum distributions at the age of 70.5. This is not the case with a Roth IRA, there are never any required distributions.