I’m considering opening either a Traditional IRA or a Roth IRA to supplement my retirement plan at work. What should I know?
Both a Traditional IRA and a Roth IRA are tax qualified retirement plans, but each has a different tax treatment. As of 2014, both IRAs allow eligible people to make contributions up to $5,500 each year ($6,500 if you’re age 50 or older) and both allow your funds to grow tax-deferred.
- In a traditional IRA, contributions are made with pre-tax dollars.
- With a traditional IRA, the withdrawals are taxed as ordinary income.
- Roth IRA contributions are made with after-tax dollars.
- In a Roth, withdrawals are exempt from taxes—meaning all of the gains go to you free and clear.
The decision as to whether to invest in a traditional or Roth IRA will typically come down to your income level and tax situation. If you are in a higher bracket currently and expect to be in lower bracket in retirement, a traditional IRA could be more advantageous. Otherwise, a Roth would be more favorable for people if they expect their retirement tax bracket to be about the same as it is today. Plus, a Roth IRA has greater flexibility for those who want to make early withdrawals, as contributions are the first to come out and are therefore, not penalized.
If you participate in an employer sponsored plan, you may not be eligible to contribute to an IRA depending on your adjusted gross income. Roth IRA eligibility is a little more flexible for 401(k) participants, but there are still income eligibility requirements.
You should consult with your tax professional and financial advisor on eligibility requirements and to confirm which IRA option is best suited for your situation.
For more information, check out this comparison chart from the IRS: http://www.irs.gov/Retirement-Plans/Traditional-and-Roth-IRAs
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