We all know that I have dubbed the 401k as the ultimate retirement vehicle however I did want to mention the differences between two major other choices. The roth IRA and traditional IRA can both be used as effective retirement accounts. Both accounts have limited yearly contribution allowances just like a 401k, and have the option of a “catch up” period which comes into effect when you are 50 years old.
Here are some of the differences. See which one may work best for you.
Tax deferral on all earnings inside the Roth
Tax-free withdrawal of all contributions and earnings (subject to a five-year holding period plus age restriction of 59 ½).
Tax-free withdrawal of your contributions at any time or age from a Roth IRA. A note on this as it applies to employer sponsored plans is that you should check with your plan administrator as each plan has their own set of rules as to when withdrawals are allowed.
Tax planning flexibility – Since there are no forced withdrawals by age 70 ½, you have more tax-planning flexibility during retirement.
If a Roth IRA owner dies, certain of the minimum distribution rules that apply to traditional IRAs will apply to the Roth.
If you file single you can contribute into a Roth until your income reaches $117,000. If you are married or file jointly it jumps to $184,000.
As of 2016 contribution limits are $5500 if under the age of 50.
Tax deferral on contributions during working years will lower your taxable income while working and can increase some tax credits.
Increasing some tax credits could actually allow you to save more.
The required minimum withdrawals must begin prior to April 1st of the year after you turn 70 ½. The RMD for any year after the year you turn 70 ½ must be made by December 31st of that later year. If these are not made, you can incur a 50% penalty on any amount not taken that was due.
Inherited IRAs have a complete set of RMD tables and rules which will not be discussed here.
They both are great in their own individual ways and as an individual your needs may differ. For young investors the roth is more popular and likely a better investment choice. Allowing your money to grow tax free for 40+ years can yield some pretty amazing results!