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Suit up your accounts in tax armor
An Individual Retirement Arrangement, also known as an Individual Retirement Account or IRA, is a retirement savings plan that offers
tax benefits. In reality, IRAs are not actually accounts; rather, an IRA is a coat of armor that goes around various types of accounts or
investments to protect them from taxes. By understanding the tax differences between a Roth IRA and Traditional IRA, you can choose which option is going to save
you the most taxes — when you need it.
Roth IRAs vs. Traditional IRAs
In short, Traditional IRAs help people avoid taxes upfront, but when the money is distributed during retirement, taxes
must be paid on both principle and interest. In contrast, people fund Roth IRAs with money that’s already been taxed. The
Roth IRA then grows tax-free; taxes are not collected on the earnings. This is especially beneficial for young adults since
compounding increases exponentially over time, and because individuals generally earn more as they age, so their tax rate
also increases with age.
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Traditional |
Roth |
| Tax benefits |
Possible tax deductions on contributions made during the year. But deductions depend on income and participation in an employer-sponsored plan. |
The magic of a Roth IRA is that earnings grow tax-free. |
| What is taxed? |
Principal and earnings when you withdraw funds |
The money you contribute to a Roth IRA has already been taxed.
Thereafter, principal and earnings are not subject to taxes, as long as you stay within the distribution guidelines. |
| When is it best? |
If you want to save money this year. |
If you want to save money in the long run.
Roth IRAs are especially beneficial for young investors and those that may be in a higher tax bracket during retirement. |
| Contributions |
Individual - $5,000
$1,000 catch-up contribution for those 50 years and older |
Individual - $5,000
$1,000 catch-up contribution for those 50 years and older |
| Income limits on new contribution |
None |
Married couples filing a joint tax return can only make a partial
contribution if their income is between $166,000 and $176,000.
Singles can only make a partial contribution if their income is between $105,000 and $120,000. |
| Income limits on conversions |
None |
None |
| Age restrictions |
Must be under 70 ½ |
None |
| Required minimum distribution |
Start at age 70 ½ |
None |
| When you can withdraw penalty-free |
59 ½ |
May withdraw contributions any time; earnings at 59 ½ and after five years |
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