Investing for retirement is one of the most important things you can do for your future. Yet an employer-sponsored savings plan, such as a 401(k), may not be enough to provide the savings you need since there are many risks to be prepared for. For many, an Individual Retirement Account is one of the best ways to accumulate additional retirement savings on a tax-advantaged basis.
There are two main types of IRAs, Traditional and Roth. Both have the same contribution limits, the same catch-up provisions for people age 50 and older (for this year’s amount, go to the Internal Revenue Service website, http://www.irs.gov), and both allow your investment earnings to compound tax-deferred until you start taking withdrawals, typically at retirement.
To help determine which IRA is right for you, consider how they differ.
You can contribute to a Traditional IRA, provided you (or your spouse, if you are married and file jointly) have earned income and you will not turn age 70 ½ by the end of the year. In contrast, Roth IRAs are subject to income limits, which means not everyone can take advantage of one. (To learn more about your eligibility, consult the IRS website at http://www.irs.gov).
Contributions to a Traditional IRA may be tax deductible, subject to certain requirements. And any contributions you make may help lower your taxable income in the year in which you make them. With a Roth IRA, contributions are made with after-tax dollars, meaning the money you contribute has already been taxed, with no benefit of a deduction.
Other Tax Advantages
When money is taken from a Roth IRA at retirement, it’s potentially tax-free — and that includes your tax-deferred earnings. That’s different from a Traditional IRA, which is fully taxable at current tax rates when withdrawn.
Traditional IRAs require you to begin taking minimum required distributions at age 70 ½ — whether or not you need the money. If you fail to take your distribution, you’ll face stiff penalties.
In contrast, Roth IRA owners are not subject to mandatory withdrawals at age 70 ½. This means you can extend the tax advantages of your account longer than with a Traditional IRA.
Which is Better?
One rule of thumb suggests that if you think your tax rate today is higher than it will be in retirement, a Traditional IRA may make sense. Conversely, if your tax rate is lower than you think it will be in retirement, a Roth IRA may be the better choice, assuming you qualify for one. However, because everyone’s situation is different, be sure to consult with a financial representative or tax professional to carefully weigh all the factors and determine which IRA is best for you.
This information is not considered legal or tax advice. Please consult your tax attorney.
Article prepared by Northwestern Mutual with the cooperation of Marnique Sparago. Marnique Sparago is a Financial Representative with Northwestern Mutual, the marketing name for The Northwestern Mutual Life Insurance Company (NM), Milwaukee, Wisconsin, and its subsidiaries. Marnique Sparago is based in Boca Raton, FL. To contact Marnique Sparago, please call (561) 962-2925, e-mail at firstname.lastname@example.org, or visit nmfn.com/marniquesparago.