Why the Roth IRA Beats the Traditional
In the 1980s the individual retirement arrangement was established by Congress to allow Americans to set aside money for their retirement. We now refer to this as the traditional IRA for in 1998 Congress created an alternative called the Roth IRA which has several advantages over the traditional IRA in many cases. The Roth IRA is a very different animal than the traditional IRA and has many features that the original did not. For most people there are several Roth IRA advantages that we will look at. Let’s take a look at some of these advantages.
The most popular feature (and the greatest advantage) of the Roth IRA is the fact that once an individual has reached age 59 and 1/2 they can withdraw their retirement monies tax free. In exchange for this privelidge you will forfeit the tax deduction that you would normally receive for a traditional IRA when first depositing your contribution. So it essence you are trading a small (but certain) tax break up front for a much larger (though uncertain) tax break later in life. This is the feature of the Roth IRA which has contributed the most to its popularity.
In a traditional IRA, you do get the tax deduction on your initial contribution. However, later, when it is time to take distributions (withdraw your money) you will pay taxes on the sum gain realized in your account. Another issue is that the money upon withdrawal is taxed as income as opposed to as a capital gain. Therefore, if you are in the 28% income tax bracket, more than a quarter of your money will go to the tax man.
Another key component of the Roth IRA (and this is true for a traditional IRA as well) is that within your account you are not taxed on individual transactions. Unlike a regular brokerage account, an IRA shelters you from taxable events until it is time to withdraw the money (traditional IRA) or forever (Roth IRA). Therefore, if your time horizon is especially long, an IRA is great choice of vehicle for your investments.
One key distinction between the two, the Roth and the Traditional, is that with the Roth there is no point where you will be required to take your money out. In a traditional IRA, once you reach the age of 70 and 1/2 you are required to begin to withdraw your money or you will face a penalty. In the case of the Roth IRA, however you are not required by law to take deductions at any age. As a matter of fact, you may, if you choose, keep funding your account until you reach 110 years old, assuming that you live that long.
A key question for the future however is whether the IRA will become a thing of the past. Some have asserted that Congress will have a tough time keeping their hands off of this retirement money for so long. The reason for this is simple. Many believe that government wants their cut of this money and so they will take it. Because of this, many wonder if the main argument in favor of the Roth IRA, the tax advantages, will become moot. So the Traditional IRA, which offers an upfront tax advantage may be the safer way to play it. At this point, it seems uncertain that the current system will be maintained indefinitely. Depending upon your time horizon before retirement, you will have to judge if you believe the government can keep its hands off your money for that long before making your decision.
In summation, those are the essential advantages and disadvantages of the Roth IRA over the traditional IRA. There are many other factors to consider when planning for your retirement including IRA limits and Roth IRA limits so make certain to do your due diligence before deciding on a course of action.
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