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Roth IRA Vs Traditional IRA: Contributions, Investments, Mutual Fund Growth And Taxes
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Published: May 16, 2007
When faced with all the options for retirement funds, deciding how to invest can feel like choosing a drink at Starbucks. Tall or venti? Regular or decaf? Whipped cream or foam? Flavored syrup or extra shot?The options can be overwhelming—even paralyzing. There is comfort recognizing that the two most popular choices for retirement investments, Traditional IRA's and Roth IRA's, are popular for good reasons.
IRA stands for Individual Retirement Arrangement. Both traditional IRA's and Roth IRA's serve as long-term savings plans available for anyone accruing taxable income, unless their income is above a certain level. Contributions per year are limited based on income, and the maximum possible yearly IRA contributions allowed in 2008 are $6,000.
The main difference between a Roth IRA and a traditional IRA is tax structure. Roth IRA contributions are made after the tax man has collected on the income being invested. Down the road, when contributions are withdrawn, the hassle of taxes will be out of the way. If the appropriate steps are followed, all of the interest earned by the Roth IRA investments is miraculously untouched by federal income taxes. Contributions to a traditional IRA account, on the other hand, are often tax-deductible. Taxes on the investments and earnings are not paid until later, when the money is distributed.
Neither situation is inherently better. If an investor is in a 15% tax bracket now and expects to be in a 30% tax bracket when retired, paying taxes up front with a Roth IRA account would likely save money. However, retired individuals who are in a lower tax bracket than when they invested will end up with the most usable cash from using a traditional IRA. In fact, money invested in a traditional IRA at times is never taxed at all. This happens in the case of death prior to retirement or retirement with income falling below a certain tax threshold.
Another difference between a Traditional IRA and Roth IRA is withdrawal requirements. Roth IRA owners are free to withdraw as much as they have contributed at any time (not including earnings above that amount). However, distribution of Roth IRA earnings before the five-year holding period or before the individual reaches the age of 59 ½ will be taxed and a penalty of ten percent will be charged. Traditional IRA owners, on the other hand, are subject to annual minimum distributions once withdrawals have begun after the minimum age of 59 ½ . Forced withdrawals are also imposed once the investor is over the age of 70 ½ .
How to invest an IRA is a whole different cup of coffee. Conservative choices include federally insured banks or credit unions. Investment companies like Charles Shwab and Merrill Lynch are able to invest IRA's and generate considerable mutual fund growth over the years. According to Blue Collar Dollar, over two thirds of those IRA owners invest in mutual funds. The remaining IRA accounts are generally invested in individual stocks, banks, and annuities.
It's a good idea to meet with a financial advisor to decide whether a traditional IRA or Roth IRA (or both) is most appropriate. There is a completely unique language to be learned when entering the retirement savings world, and translators and tour guides can be life saving. None of us stayed at the Starbucks counter forever. Likewise, weighing options for retirement accounts is only the first part of the story. Taking a risk and reaping the rewards is the even more exciting sequel.
Sources:
Do You IRA? A Look at the Program Thirty Years Later. Blue Collar Dollar. 1998 -2005. BonPaulProductions. 15 May 2007. http://bluecollardollar.com/do_you_IRA_05.html.
Is a Roth IRA right for you? Consumer Research Guide. 15 May 2007. http://www.free-consumer-info.com/roth_ira.htm?gcl id=CMqyw7aZkYwCFQL2ggodLxPbBQ.
“Roth IRA.” Wikipedia. 1 May 2007. 15 May 2007. http://en.wikipedia.org/wiki/Roth_IRA.
Kennon, Joshua. “Traditional IRA and Roth IRA Contribution Limits.” About: Investing for Beginners. 2007. About, Inc. 15 May 2007. http://beginnersinvest.about.com/cs/iras/a/iracont ribution.htm.
McKinney, Patrick and Jenny. “Roth IRA.” About: Retirement Planning. 2007. About, Inc. 15 May 2007. http://retireplan.about.com/cs/irasandroths/a/roth _ira.htm.
Silva, D. “A Quick Guide to Understanding Your Individual Retirement Account.” Top Ten IRA Funds Websites—Traditional, SEP, Simple, Roth and more. Solution 21 Internet Guide. 15 May 2007. http://solution21st.com/investment/ira.htm?OVRAW=I RA%20mutual%20fund%20growth&OVKEY=ira%20mutual
IRA stands for Individual Retirement Arrangement. Both traditional IRA's and Roth IRA's serve as long-term savings plans available for anyone accruing taxable income, unless their income is above a certain level. Contributions per year are limited based on income, and the maximum possible yearly IRA contributions allowed in 2008 are $6,000.
The main difference between a Roth IRA and a traditional IRA is tax structure. Roth IRA contributions are made after the tax man has collected on the income being invested. Down the road, when contributions are withdrawn, the hassle of taxes will be out of the way. If the appropriate steps are followed, all of the interest earned by the Roth IRA investments is miraculously untouched by federal income taxes. Contributions to a traditional IRA account, on the other hand, are often tax-deductible. Taxes on the investments and earnings are not paid until later, when the money is distributed.
Neither situation is inherently better. If an investor is in a 15% tax bracket now and expects to be in a 30% tax bracket when retired, paying taxes up front with a Roth IRA account would likely save money. However, retired individuals who are in a lower tax bracket than when they invested will end up with the most usable cash from using a traditional IRA. In fact, money invested in a traditional IRA at times is never taxed at all. This happens in the case of death prior to retirement or retirement with income falling below a certain tax threshold.
Another difference between a Traditional IRA and Roth IRA is withdrawal requirements. Roth IRA owners are free to withdraw as much as they have contributed at any time (not including earnings above that amount). However, distribution of Roth IRA earnings before the five-year holding period or before the individual reaches the age of 59 ½ will be taxed and a penalty of ten percent will be charged. Traditional IRA owners, on the other hand, are subject to annual minimum distributions once withdrawals have begun after the minimum age of 59 ½ . Forced withdrawals are also imposed once the investor is over the age of 70 ½ .
How to invest an IRA is a whole different cup of coffee. Conservative choices include federally insured banks or credit unions. Investment companies like Charles Shwab and Merrill Lynch are able to invest IRA's and generate considerable mutual fund growth over the years. According to Blue Collar Dollar, over two thirds of those IRA owners invest in mutual funds. The remaining IRA accounts are generally invested in individual stocks, banks, and annuities.
It's a good idea to meet with a financial advisor to decide whether a traditional IRA or Roth IRA (or both) is most appropriate. There is a completely unique language to be learned when entering the retirement savings world, and translators and tour guides can be life saving. None of us stayed at the Starbucks counter forever. Likewise, weighing options for retirement accounts is only the first part of the story. Taking a risk and reaping the rewards is the even more exciting sequel.
Sources:
Do You IRA? A Look at the Program Thirty Years Later. Blue Collar Dollar. 1998 -2005. BonPaulProductions. 15 May 2007. http://bluecollardollar.com/do_you_IRA_05.html.
Is a Roth IRA right for you? Consumer Research Guide. 15 May 2007. http://www.free-consumer-info.com/roth_ira.htm?gcl id=CMqyw7aZkYwCFQL2ggodLxPbBQ.
“Roth IRA.” Wikipedia. 1 May 2007. 15 May 2007. http://en.wikipedia.org/wiki/Roth_IRA.
Kennon, Joshua. “Traditional IRA and Roth IRA Contribution Limits.” About: Investing for Beginners. 2007. About, Inc. 15 May 2007. http://beginnersinvest.about.com/cs/iras/a/iracont ribution.htm.
McKinney, Patrick and Jenny. “Roth IRA.” About: Retirement Planning. 2007. About, Inc. 15 May 2007. http://retireplan.about.com/cs/irasandroths/a/roth _ira.htm.
Silva, D. “A Quick Guide to Understanding Your Individual Retirement Account.” Top Ten IRA Funds Websites—Traditional, SEP, Simple, Roth and more. Solution 21 Internet Guide. 15 May 2007. http://solution21st.com/investment/ira.htm?OVRAW=I RA%20mutual%20fund%20growth&OVKEY=ira%20mutual
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