financialfitnessblogs.com

In the 1980s the individual retirement arrangement was established by Congress to allow Americans to set aside money for their retirement. We now refer to this as the traditional IRA for in 1998 Congress created an alternative called the Roth IRA which has several advantages over the traditional IRA in many cases. The Roth IRA is a very different animal than the traditional IRA and has many features that the original did not. For most people there are several Roth IRA advantages that we will look at. Let’s take a look at some of these advantages.

The most popular feature (and the greatest advantage) of the Roth IRA is the fact that once an individual has reached age 59 and 1/2 they can withdraw their retirement monies tax free. The alternative arrangement in the Traditional IRA allows one to take a tax deduction upon putting their money into the IRA but they have to pay taxes on it when they withdraw it. What this boils down to is a simple question of exchange. Do you want to take a gauranteed tax break up front or hope for a much larger tax break in the future. The Roth IRA owes its tremendous popularity to this feature; the fact that money is allowed to grow and be withdrawn tax free.

With the way that the current tax code is constructed, the traditional IRA offers a guaranteed tax break on the initial contribution. Unfortunately, there is a downside to this as well. Later in life, when retirement arrives, you will be forced to pay taxes on the growth of your money. Another issue is that the money upon withdrawal is taxed as income as opposed to as a capital gain. Therefore, if you are in the 28% income tax bracket, more than a quarter of your money will go to the tax man.

Another key component of the Roth IRA (and this is true for a traditional IRA as well) is that within your account you are not taxed on individual transactions. Unlike a regular brokerage account, an IRA shelters you from taxable events until it is time to withdraw the money (traditional IRA) or forever (Roth IRA). Therefore, if your time horizon is especially long, an IRA is great choice of vehicle for your investments.

One key distinction between the two, the Roth and the Traditional, is that with the Roth there is no point where you will be required to take your money out. With the case of the traditional IRA once you are older than 70 1/2 years you will be forced to begin to take distributions or suffer a monetary penalty. However, with the ROth IRA there will be no point where you are required to take money out by law. In fact, you can continue to fund your Roth IRA (without withdrawing any money) until you are 100 if you so desire.

Going forward, many have questioned how long the current tax treatment will remain in effect. There have been rumblings recently that Congress will change the tax code so that your money is no longer sheltered from taxes as is the case with the Roth IRA. The reason for this is simple. The government wants to provide more services and because of this they need more revenue. Because of this, many wonder if the main argument in favor of the Roth IRA, the tax advantages, will become moot. So the Traditional IRA, which offers an upfront tax advantage may be the safer way to play it. At this point, it seems uncertain that the current system will be maintained indefinitely. Depending upon your time horizon before retirement, you will have to judge if you believe the government can keep its hands off your money for that long before making your decision.

In summation, those are the essential advantages and disadvantages of the Roth IRA over the traditional IRA. There are many other factors to consider when planning for your retirement including IRA limits and Roth IRA limits so make certain to do your due diligence before deciding on a course of action.