When planning for retirement, you may have come across two primary types of Individual Retirement Accounts (IRAs). Each offers its own advantages and drawbacks.
The key difference is whether or not you will pay taxes on your savings when they are withdrawn during retirement. Traditional IRAs offer an upfront tax break, while Roth IRAs do not.
Taxes
Taxes can be a factor when selecting which type of IRA to open, and both Traditional and Roth IRAs offer their advantages. For instance, a Traditional IRA may be more advantageous if you anticipate that your income tax rate will be lower in retirement than it is now.
Roth IRAs offer tax-exempt investment growth and may be the better option for people with long-term plans. Furthermore, certain criteria can be met that allow tax-free withdrawals of earnings if you meet them.
In most cases, contributing after-tax money to a Roth IRA makes financial sense. You will owe income taxes on withdrawals, but they tend to be much smaller than what you would owe if paid upfront.
Required Minimum Distributions
As a retirement savings account owner, you may be subject to required minimum distributions (RMDs) from traditional, SEP and SIMPLE IRAs as well as qualified employer-sponsored plans like 401(k)s. These distributions are tax-exempt until you take them out.
The IRS requires you to begin taking Required Minimum Distributions (RMDs) from your IRA and retirement plan accounts once you reach age 72 or 73, depending on the terms of the account. In certain instances, however, you may be able to postpone taking RMDs until after retirement.
Roth IRA owners don’t need to take RMDs until their death, however your beneficiaries must still fulfill their own RMDs if you have not designated them as an individual.
When inheriting an IRA, your distribution requirements vary based on whether you’re a spouse or non-spouse beneficiary, the year of inheritance and any exception criteria that apply. Your Ameriprise financial advisor can assist in selecting an approach that’s most advantageous for you.
Early Withdrawal Penalties
Before retirement, don’t take money out of your Traditional or Roth IRA without first understanding its early withdrawal rules and exceptions. Doing so could result in heavy taxes and penalties – so be sure to understand all relevant details before taking a premature withdrawal.
For instance, if your doctor certifies that death will take place within seven years of withdrawal, you can withdraw up to $10,000 without penalty.
Additionally, if an emergency arises that necessitates you to withdraw money from your Traditional or Roth IRA account before age 59 1/2, those funds can be used for expenses like medical insurance premiums or higher education costs – provided you meet certain criteria.
To determine how much cash you need, carefully weigh the cost of taxes and penalties against your need for cash flow. It may also be beneficial to speak with a financial advisor who can offer tailored advice tailored to your individual situation.
Flexibility
There’s no denying the tax advantages provided by both Traditional and Roth IRAs, but which one is best for you depends on your current situation, future expectations of taxes, and financial objectives. That is why it is essential to comprehend the differences between these two retirement accounts so you can decide which option makes most sense for your needs.
Ideally, you should contribute to both types of accounts in order to give yourself both taxable and tax-free withdrawal options when reaching retirement age. This strategy is known as tax diversification, and it’s a wise one.
If you’re a younger investor, a Roth IRA could make more sense as it offers greater flexibility when retirement comes around. Roth IRAs don’t require minimum distributions, so you can keep savings in the account for as long as desired. Plus, when you convert your traditional IRA into a Roth IRA, all contributions are tax-exempt and any investment gains also remain tax-free.
