By Chris L. Meacham, CPA, Cornerstone Wealth Management
When it comes to retirement accounts, many people don’t know the difference between a traditional IRA and a Roth IRA, or they might assume the differences are negligible. But Roth accounts carry many solid advantages, one of which is that they are extremely tax-friendly. And while many financial advisors advocate Roth IRAs for younger investors, they may actually benefit those of all ages depending on their situation. The biggest disadvantage of a Roth IRA compared to a traditional IRA is that contributions are after-tax money. So you experience an immediate hit. But other benefits of a Roth RIA may make that immediate hit worthwhile. The following four main differences might help you decide if a Roth IRA is right for you.
1. Tax breaks
Probably the biggest advantage to putting your money in a Roth IRA is the tax breaks you’ll see later. While you will have to pay income tax on your contribution upfront, the income you’ll receive later is untouched by the IRS. Once in retirement, the withdrawals come to you completely tax-free. Additionally, the IRS will also not tax any of the earnings. These two benefits will create a highly valuable tax-free stream of income in retirement that you will not find with a traditional IRA.
2. Quick cash
Another benefit of a Roth IRA, is that it can serve as a source of quick accessible cash should the need arise. Contributions can be withdrawn penalty-free at any time. If you want to access more than your contributions (meaning the growth and income of the investments) before you turned 59.5 years old and before the account has been open for five years, you will pay penalties and taxes on that portion. However, there are several exceptions to those restrictions on the growth and income portion that include:
-- first-time home purchase up to $10,000
-- postsecondary education expenses
-- back taxes
-- unreimbursed medical expenses that exceed 10% of AGI (7.5% if born before 1949)
3. Continued growth
A couple of the more limiting aspects in a traditional IRA is that you are forced to take distributions when you turned 70.5 years old, and you have to pay taxes on that money. Additionally, you are no longer able to make contributions to the account. In a Roth IRA, however, there are no minimum distributions, and you get to choose when to start tapping into the account. Secondly, you can continue to contribute to a Roth IRA indefinitely as long as you have earned income, so if you are still earning income well into your 80’s, you can continue to grow the account.
4. Benefiting future generations
The benefits of a tax-free retirement account get passed down to your heirs. The income is left alone by the IRS and your beneficiaries can use it for the span of their lifetime. So when you take advantage of a Roth account, you are also passing the benefits down to future generations.
The main catch to the Roth account is that you have to pay taxes upfront on the contributions, but as I just laid out, the later benefits may be well worth it. After all, isn’t that the purpose of a retirement account – to sacrifice a little now to reap the rewards later? And if you can afford to do so, the Roth IRA offers the most reward.
If your income is too high, you cannot contribute money to a Roth IRA, but you can contribute to a traditional IRA and then convert it to a Roth IRA. You may also be able to rollover your 401(k) plan into a traditional IRA and then convert it into a Roth IRA, but make sure you understand the implications of that move.
Many aspects go into the decision of whether a Roth IRA account makes sense for you. Having a professional help you with the decision is advisable.