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Roth IRA vs. Traditional IRA: And Who Is Better For You Need to Know

Roth IRA vs. Traditional IRA: And Who Is Better For You Need to Know Too much analysis when choosing the right retirement account can lead to paralysis.

For many consumers, it is best to open a retirement account through their employer and do so. There are so many options to choose from that even seasoned financial experts have a hard time finding the best route.

With more than 50% of the US workforce expected to become self-employed in the next decade, there is a great need for strong, self-sufficient retirement savings. But this is not an option available to everyone. That is why the Individual Retirement Account (IRA) has become so popular.

An IRA allows you to plan for your retirement without employer support, making it perfect for freelance IT professionals, consultants, writers, gig economy workers, and just about anyone else in a non-traditional work situation. Some consumers even opt for an IRA over an employer-sponsored plan that has few investment opportunities.

An IRA is available in two versions: Roth IRA vs. Traditional IRA. Here’s what you need to know about both.

What is an IRA?

Unlike 401 (k), an IRA does not have to be sponsored by an employer. An IRA or individual retirement account is a retirement savings plan that anyone can open on their own. This makes them particularly popular with the self-employed and those working in the charter economy.

Some people open an IRA because they have to change the value of their 401 (k) from a previous employer to a new account and are not yet eligible for the value of the 401 (k) from their new business. Consumers often open IRAs because they do not have access to an employer account or because their investment opportunities in the 401 (k) class are weak.

Investors age 50 and older can contribute an additional $ 1,000 per year. Contribution limits for IRAs are $ 6,000 per year in 2020 and generally increase annually with the cost of living.

For example, if you only make $ 5,000 a year, you cannot add the full $ 6,000 limit. The money paid to the IRA must be income and your salary must be equal to or greater than your contribution.

If your child is 15 years old and works as a poolside lifeguard, for example, she can contribute to the IRA. Parents can open an IRA for their children if the child contributes their own income. The parent can access the account until the child becomes a legal adult.

You must first choose an investment company. Opening an IRA is like opening a new bank account. The most popular companies are Charles Schwab, Morgan Stanley, Fidelity, and Vanguard.

These companies choose which funds to invest in and can even suggest how much they should save for retirement. Theft consultants, such as Betterment, Wealthfront, and Wealth Simple, also offer IRAs if you want a more thoughtful approach. Some Robo advisors even offer a telephone consultation with a human financial advisor for those who do not want to rely entirely on an algorithm.

The target date fund balances its portfolio over time. You can also choose a fund with a target date that is the basis for your retirement hope. A 25-year-old who chooses a target date of 2050 will start primarily with funds invested in stocks. As you age, the fund will be balanced to invest more in bonds.

To fund your IRA, you can link your bank account and set up regular automatic payments for a mutual fund, stock, or exchange-traded fund.

Roth IRA vs. Traditional IRA

If you have decided to open an IRA, the next step is to choose between a Roth IRA or a traditional IRA.

Roth IRA

Contributing to a Roth IRA is like a delayed bonus. The best part of choosing a Roth IRA is if you know you don’t have to taxes when you withdraw funds in retirement.  You don’t get an immediate tax credit, but you get a boost when you start drawing money when your retirement

If you leave a Roth IRA in your will, your heirs will not have to pay income taxes on the funds as long as the account has been open for more than five years. An added benefit of a Roth IRA is that it can be used as an asset transfer tool.

In 2020, married couples making less than $ 100,000 could contribute to the total limit of $ 10,000. Those who earn between $ 100,000 and $ 117,000 can contribute. A Roth IRA is only available to those who are below a certain income threshold. Couples earning more than $ 117,000 cannot contribute at all to a Roth IRA.

Those who claim to be single and head of the household can contribute a maximum if they earn less than $ 100,000. Contribution amounts are phased out for people who earn between $ 100,000 and $ 120,000 and disappear completely if they pay more than $ 120,000.

Traditional IRA

Investors choose to open a traditional IRA because they earn too much from a Roth IRA or because they want a tax credit. There are no income limits for traditional IRAs, but you must be 70.5 years of age or younger to open an account.

One of the biggest disadvantages of choosing a traditional IRA is making the required minimum withdrawal (RMD). The RMD is your age, the age of the primary beneficiary, how much your balance is worth, and if your spouse is the primary beneficiary.

Take a look at the best online brokers to find the company that suits your needs. Your brokerage firm can help you calculate the amount of RMD so you don’t get more than you need. Some may set up RMD deposits that are automatically deposited into your bank account.

If not, a penalty of  50% of the difference between the amount withdrawn and the RMD will be applied. Even if you are still working or receiving enough money through Social Security benefits, you will have to pay RMD.

A Side-by-Side Comparison for 2020

Roth Traditional
Qualifications to contribute $100,000 or less for married couples; $112,000 or less for individuals None
Yearly contribution limitations $6,000 and an extra $1,000 for those 50 or older $6,000 and an extra $1,000 for those 50 or older
Withdrawal requirements None Retirees must withdraw money from a traditional IRA starting at age 70.5
Immediate tax benefits None Contributions are tax-deductible
Future tax benefits Withdrawals won’t be taxed in retirement None
Limits to withdrawals

Withdraw contributions at any time; 10% penalty if you take withdrawals before 59.5 10% penalty if you take withdrawals before 59.5
Note: The penalty may be waived if you have a financial hardship, such as paying for college expenses or high medical bills or buying a new home.

Choosing a Roth IRA vs. Traditional IRA Doesn’t Need to be Complicated

As a general rule of thumb, choose a Roth IRA if you are young, early in your career, or if you can afford to waive the tax deduction. Choosing between a Roth account or a traditional IRA may seem daunting, but it’s mostly a simple decision. Seniors or self-employed people may prefer a traditional IRA because they want the tax deduction to reduce their taxable income.

If you think you will pay more taxes when you retire than you do now, use a Roth IRA. Here’s another simple way of thinking: Do you think you’re in a higher tax bracket now or in retirement? If you think you will have to pay fewer taxes when your retirement now uses a traditional IRA to get the tax credit.

If you now choose to choose a Roth IRA because you think your tax bracket will be higher when your retirement it is simply an assumption based on current tax laws. There is no way to accurately forecast tax rates because the tax law can change from year to year.

For example, if you have a Roth account and a traditional IRA, you can contribute $ 2500 to your Roth and $ 2500 to the traditional with a total of $ 6,000. One spouse of the married couple can contribute to Roth and the other to the traditional. Investors who cannot decide which one to employ can open up and contribute to both, but their total contribution should still be below the annual limit.

They can analyze your retirement account and tax situation to suggest a personalized strategy If you want to make the best decision, consult a financial planner. They can also help you adjust your investment strategy as your living conditions change over the years.

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