Roth vs Traditional IRA – how to choose between the two accounts?

Tax payments can be a real pain, especially if you are to worry about the frequently oscillating tax rates. Choosing between a Roth Account and a Traditional IRA only adds to this discomfort. Before going ahead and choosing one for greater savings, it is essential to be aware of what these accounts entail. A Roth IRA is a unique retirement savings account, which allows for funding through the income, post-tax-deduction.  Future withdrawals on this account tend to be tax-free. A traditional IRA account may be funded either through pre-tax or post-tax income and does not pose limits to income, unlike a Roth IRA account.

Making a choice!

In order to decide which retirement savings account seems more profitable, it is imperative to sort out the features of each and identify the differences to be able to choose wisely.

Roth IRA

  • Both – Roth and Traditional IRA accounts provide a secure path to maintaining retirement savings with tax advantages. In case of a Roth IRA, you are to pay taxes upfront, as the contributions are not deductible, so the earnings grow tax-free in this account, subject to the tax-rate ongoing at the time of retirement. If tax rate at retirement is higher than the current rate, after-tax value of the investment will be higher for a Roth account and vice versa.
  • Another difference between the two savings accounts is, with regards to, the contribution limits of each. The maximum limit for a contribution to Roth IRA is $5500 for individuals aged less than 50 years and $6500 for those aged 50 and above. Roth contributions are to be made out of household income and so, for higher household income individuals, this account may not be the wisest choice after all. However, for lower household income individuals, Roth IRA is perfect for a retirement savings account.
  • A third differentiating factor between the two is regarding withdrawals. Roth IRA offers more flexible terms for withdrawal options, whereby you are allowed to make withdrawals from your contributions made to the savings account at any time of the year, at any particular age without any income tax payments or withdrawal penalties. 10% penalty is charged on early withdrawal when accessing any earnings contributed to this account, prior to the five-year rule (this rule states that earnings may only be withdrawn when the first contribution is at least 5 years old).
  • Roth IRA has no minimum distribution rules, only if it is not an inherited Roth account. It enables you to keep your account growing tax-free for as long as you live. Contributions may be made to a Roth, post the age of 70.5 years, which may then be passed on to your next generation, if need be.

Traditional IRA

  • Tax advantages availed in the case on a Traditional IRA account are greater than in case of a Roth IRA, provided that contributions made to this retirement savings accounts are tax-deductible. If the tax rate is lower at the time of retirement than the current tax rate, the after-tax investment value in the Traditional IRA tends to be higher and vice versa.
  • Similar to the contribution limit identified for Roth IRA, the maximum limit for a contribution to a Traditional IRA is $5500 for individuals aged less than 50 years and $6500 for those aged 50 or and above.
  • Unlike the income limitations to a Roth IRA, Traditional IRA faces no such limitation and any and all individuals are allowed to freely make contributions to this account. Bear in mind that income may impact the IRA contribution that you may deduct from taxes, however. In addition to this, Traditional IRA considers tax filing status and whether or not the individual and his/ her spouse are insured by employer’s retirement plan.
  • Early withdrawals in case of Traditional IRA pose a risk of 10 percent early withdrawal penalty and the current tax rate is applied to income taken out before the age of retirement.
  • Unlike a Roth IRA, Traditional IRA has minimum distributions that must be made once you reach the age of 70.5, needed or not, but just to fulfill this requirement. This hinders the growth of the account through withdrawals. Hence, this unnecessary withdrawal makes a Traditional IRA less appealing.

Based on the various differences identified for each, a suitable retirement savings account may be chosen depending on the distinctive circumstances identified in both the cases above. Based on circumstances, the perfect plan may be adopted. For instance, if you fall into a low tax-bracket and are in the early stage of your career, a Roth IRA is a likely option for you. In case you fall into a higher tax-bracket and are close to retirement, a Traditional IRA is a more feasible option.

In addition, it is always important to consult your financial advisor along with your certified public accountant in deciding on the investment vehicle which is right for you.  If you have any questions please contact Chris Duncan, CPA at Duncan and Company at (843) 743-5005)



About the Author:

Chris Duncan, CPA

As a South Carolina native, Chris has spent the better part of his life in the Charleston area. Chris graduated from The Citadel with a degree in Business Administration (Accounting Concentration) in 1999. Chris has spent his career working with large manufacturing and distribution companies, real estate developers, as well as many high net worth individuals. In 2006, Chris launched his own CPA firm. For the past twelve years, Chris has worked as a local CPA and provided services to both individuals and commercial clients in a variety of industries to include accounting, bookkeeping, tax, and payroll services.

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