What Are Differences Between Traditional IRA and Roth IRA? Which IRA Is Right For You?
There are four types of IRAs that Sunwest Trust acts as a custodian for traditional IRAs, Roth IRAs, SEPs (Simplified Employee Pension), and SIMPLE (Savings Incentive Match Plan for Employees) retirement plans.
SEP and SIMPLE accounts are usually more company- or business-based accounts, while traditional and Roth IRA accounts are normally chosen by the single account investor. There are a variety of reasons for choosing one over another, we will delve into a comparison of a traditional IRA versus a Roth IRA account.
[0:11] There are different types of IRAs, but which one is right for you?
[0:40] With a Traditional IRA, account contributions are made with pre-tax dollars.
[1:15] Learn the advantage of having a tax-deferred account, and when you’re allowed to start taking money out.
[1:55] What happens if you’re covered by another retirement account?
[2:31] A Roth IRA account uses after-tax dollars for contributions, allowing you to take the money out tax-free!
[2:49] Here are two important things to keep in mind before deciding to take money out.
[3:07] Once you’ve decided what IRA account to open, here’s how to set things up!
[3:27] When opening your account, what’s the difference between Traditional IRA and Roth?
[3:58] Which type of IRA account does Terry recommend?
[4:27] Here’s how to get more topics and helpful information!
Traditional IRA vs. Roth IRA – What The Difference?
A traditional IRA account‘s contributions consist of pre-taxed dollars, i.e. money that has not been taxed yet. Your contributions will come from your gross income and go into your individual retirement account. You can start taking it out after you’ve turned 59 ½, and you will pay taxes on the money as you take it out.
A Roth IRA account’s contributions consist of after-tax dollars, better known as money that has been taxed before it was placed in the IRA. When you turn 59 ½ (and as long as you have had a Roth account for five years prior to taking the money out), your withdrawals will be entirely tax-free.
What Are The Real Advantages of IRAs Whether Traditional or Roth?
There are advantages and disadvantages to both types of IRAs. The Traditional IRA is pre-tax money, which means that your contributions can be tax deductible. The tax deductibility of your contributions depends on whether or not you are contributing to another type of qualified retirement plan, such as a 401k or 403b plan. Your deductibility also depends on your annual income. If you have questions about this, please contact a trusted tax professional.
IRA Contributions – and your Roth and Traditional IRA Contribution Limits
Regardless of the types of IRA contributions you make, almost all of them can be made through your custodian of choice. Your IRA contributions are not counted as part of your amount of taxable income, under certain conditions. As of this writing, you can only defer taxes if:
- You only make contributions up to $5,500, or $6,500 if you are over 50. Excess IRA contributions are taxed at a rate of 6%.
- You also have a retirement account at work, and your adjusted gross income is between $60,000 – 70,000 ($96,000 – $116,000 for couples). At this point, the deductions are phased out.
- You do not turn 70 ½ or older in the tax year of your contribution.
- Your contributions are from an earned income (not a passive income).
You can also put unlimited after-tax dollars into a traditional account, but be sure to keep track of those on form 8606. Any later withdrawals are not taxed again.
There are income limits when contributing to a ROTH IRA – in 2017 a single filer cannot earn more than $129,000, while a couple filing jointly cannot earn more than $191,000.
Tax advisors recommend (again, we are NOT tax advisors) that you add any allowable extra contributions that you can up to the April 15th deadline of each tax year to offset taxable income for that year.
Don’t Get Taxed Twice For Your Company’s 401k Contributions
If your company’s 401k is contributing to your traditional IRA, keep track of those contributions. There is a chance they are post-tax contributions, and you don’t want to be taxed a second time when you withdraw that money.
Two Very Different Minimum Distribution Rules – Traditional IRA vs. Roth IRA
Another difference is the Required Minimum Distribution rule. With a Traditional IRA, you MUST begin taking distributions from your IRA at the age of 70 ½. The number of your distributions are determined by taking the total value of all IRAs that you have and dividing that total by the number corresponding to your age on the Life Expectancy Table. Your custodian will be able to help you determine this number. With a Roth IRA, you are not required to take Required Minimum Distributions.
Withdrawal Rules – Traditional IRA vs. Roth IRA
Two things to keep in mind when you want to take money out (distributions) of your Roth account:
- You must be 59-½ years old or older.
- The account has to have been established for 5 years prior to taking distributions.
- There are no minimum distribution rules.
With your traditional IRA account, you must:
- Begin minimum required distributions the year you turn age 70 ½ or face a tax penalty of 50%.
If you use the 4 percent rule or some other strategy to generate a retirement paycheck, or if you invest in a managed payout fund that automatically generates a retirement paycheck for you, such as funds sponsored by Fidelity or Vanguard, you might not be withdrawing sufficient amounts to cover the full RMD (required minimum distributions) that applies to you.
– Steve Vernon, retirement program consulting actuary
The Difference Between a Traditional IRA and a Roth IRA – and which IRA account you should open
- Traditional IRA contributions are made with pre-taxed dollars and are taxed as they are distributed.
- Roth IRA contributions are made with after-taxed dollars and are distributed tax-free.
If you are in a situation where you can make after-tax contributions and you can get a good return on your money inside your account, Roth would be a great way to go. The beauty of a Roth IRA is that all growth is tax-free, so it will never be taxed. The Roth is also more flexible because you don’t have mandatory withdrawals and so it is easier to make penalty-free withdrawals.
How to Set up an IRA Account?
Once you’ve decided on which type of account is best for you, the process of setting up an account is straightforward. Here at Sunwest Trust, you can start by going to SunwestTrust.com, click on “OPEN SDIRA” (where you will find a couple videos which further explain IRAs and custodians), click on “Open an Account with Sunwest Trust“ near the top of the page, and on the subsequent page, and finally click on your choice of IRA.
Whether you choose a traditional or a Roth account, we will still need the following:
- Account Application (first page)
- Hold Harmless (all 5 pages)
- Fee Disclosure
- Transfer form from another IRA custodian
- A clear copy of your driver’s license or passport
Set up an IRA account with Sunwest Trust. Also, feel free to call with any questions.
IRAs allow your retirement savings to grow in a tax-deferred or tax-free environment.
Tax-deferred growth means that you will contribute now while you are working and get a tax deduction for your IRAs. When you retire, you will no longer be making as much income and therefore will be in a (possibly) much lower tax bracket when you pay taxes on the money.
Tax-deferred (Traditional IRA) – This refers to money which is tax deductible at the time of contribution. The money will continue to grow tax-deferred until you reach retirement age (59 ½) and start taking it out. Your money will be taxed at your current tax bracket at the time of the distribution.
Tax-free (Roth IRA) – Contributions to a Roth are after-tax, which means that they are NOT tax deductible. Both the principle and the earnings (your contributions and the money it makes from investments) will NOT be taxed when you start taking distributions from your account at age 59 ½.
- Traditional and Roth IRAs are taxed differently.
- There can be contribution limits on your self-directed IRA account.
- You can set up your IRA account with ease at Sunwesttrust.com.
Summary of Recommended Resources:
- H&R Block opens in a new windowRules For The Traditional And Roth IRA Contributions
- Bankrate Avoid These 8 Common IRA Mistakes
Hi, my name is Terry White. This is Tuesday at Two with Sunwest Trust. Thank you for taking your time to join us. I’m going to kind of back up a little bit and just talk about some really basic things because we’ve had some questions about actually setting up an account.
First off, I want to tell you there are basically four types of individual retirement accounts or IRA’s. The ones you’ve heard most about are a traditional account and a Roth account. And, then, there’s a SEP or a simple with more of a business-based account. Today, we’ll just talk about traditional accounts and Roth accounts.
A traditional account is an account where the contributions made to the account in most cases are made with pre-tax dollars. So if you decide, not this time of year, but April 15th, that you’ll go to your accountant and a lot of times, they’ll say, “You know, if you make a contribution to your individual retirement account, it’ll save you some money in taxes.”
The reason for that is it will reduce your gross income. That money comes off your gross income, goes into the individual retirement account, and then that’s called a tax-deferred account because the money sits inside your traditional IRA until you decide to start taking it out, which is after you’ve turned 59 ½, and then you pay taxes on the money as you take it out. That’s the way in which a traditional account works and that’s what the majority of people have.
Now, there’s a few caveats. If you make too much money – I’m not sure what the amount is, I think it’s over $160,000 for an individual and $200,000 for a couple, but don’t quote me on those numbers. You need to Google it and find out because they change every year. That’s a traditional account that most of us use.
The other thing I want to point out is if you’re covered by another account (say at your work), you have a 401k, then you may not have pre-tax dollars going into your traditional account. So you can put after-tax dollars into a traditional account and then you keep track of those on form – I believe it’s 8606. And, then when you take them out, those are not taxed again.
But typically, the contributions to a traditional account are pre-tax dollars and then taxes that come out. So that’s commonly referred to as a ‘tax-deferred’ account.
Now, we also have a thing called a Roth. With the Roth account, the money that goes into that is after you’ve paid tax. It’s after-tax dollars. They go into the Roth account and they, hopefully, will grow. And then when you take them out when you turn 59 ½, they will come out tax-free.
There are two other things that you have to keep in mind. Number one is that you have to be over 59 ½ for them to come out tax-free and you have to have had a Roth account for five years prior to taking the money out.
Given those two things, a Roth account is considered tax-free.
How do you go about setting those accounts up? Well, it’s very easy. You can go to our website and you click on ‘Self-directed IRA’. Then it’ll ask you if you want traditional or Roth. They’re pretty much the same. The documentation for the application is the same, but the account documentation is somewhat different.
Everything else is going to be the same as far as you’re concerned. You’re still going to have to give the same information on the application. You still have a fee disclosure (fees are the same on the two accounts). You have an account holder disclosure and hold harmless form, as well as transfer forms. We need a copy of your driver’s license and your passport. All that’s the same, it’s just the way the account is treated after it’s been set up. Is it a traditional IRA, in which case it will be tax-deferred or is it a Roth account, in which case, it will be tax-free.
If you were in a situation where you can make after-tax contributions and you can get a good return on your money inside your account, Roth would be a great way to go about it.
I hope that’s been valuable for you. We would appreciate it if you would take some time and comment on this video, or get in touch if you have questions. We’d love to answer your questions and maybe use those as a topic for future videos. We’d also like it if you would go to our Facebook page and like us there. If you’re interested in other topics, go to our website and click on ‘Sunwest Trust News’ and there’s a whole bunch of blogs and videos there about various other topics.
Thank you for taking the time to watch this video today. I look forward to seeing you again next week.