This is a question that comes up fairly often, as there is a lot of confusion around the two. Since we are wrapping up tax season, let’s begin with some tax considerations: the IRA creates a tax deduction when it is contributed, while the Roth IRA does not. However: money withdrawn from an IRA is ALL taxable, compared to the Roth IRA where withdrawals including the increases in value over time are NOT taxable, within certain guidelines.
Contribution Limitations: If you work, or have earned income and are not contributing to an employer’s retirement plan, you may contribute $6,000 per year to either of these IRA’s. You can add an additional $1,000 if you are over age 50.
Note: If you are a single taxpayer, your income must be less than $137,00 to contribute to either type of IRA, and if married filing jointly, less than $203,000.
Special Contribution Consideration: If you have a tax year when your income tax rate is low, you may want to consider a Roth Conversion: This is where you take money that is in your IRA and convert it to a Roth IRA, paying the tax on the amount that is transferred. There are no restrictions on the amount you can convert, but please only do it after consulting with your tax advisor. There is no age requirement to make these conversions. This process allows the funds converted to continue to grow tax free, for you and/or for your heirs.
When can you withdraw from each type? You generally will need to wait until age 59 ½ before beginning to withdraw from either an IRA or Roth IRA. In most cases, distributions from either before age 59 ½ will result not only in taxes, but a tax penalty of 10% on top of the taxes! However, there are some exceptions for the Roth IRA’s that will not result in tax penalties, particularly if the account has been established for at least five years. These include:
- You may withdraw a lifetime maximum of up to $10,000 to pay for a first-time home purchase
- You may use withdrawals to pay for qualified education expenses (although we believe there are better vehicles to use for these expenses).
- If you are unemployed and need to pay for un-reimbursed medical expenses or insurance.
- If you become disabled
Who should consider using a Roth IRA? Anyone with earned income should consider it after consultation with their financial advisor/tax preparer. For younger people starting out, the Roth is a preferred vehicle, especially before you have the opportunity to participate in an employer-provided retirement plan.
For individuals approaching retirement, with reduced income and lower tax rates, consider the Roth Conversion- keeping in mind that you will need to be prepared to wait five years before distributing any earnings from the Roth, but you can still distribute principal.
The Roth IRA can be a very effective tool in your strategic financial plan, and one that we are happy to discuss with you in the context of your particular situation.