My Financial Tips

As a provision for retirement, the U.S. government created the individual retirement arrangement more than tweny years ago. 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 traditional IRA was found to be lacking certain features and the Roth IRA was created to address its shortcomings. For most people there are several Roth IRA advantages that we will look at. Today people have a choice between the two retirement vehicles. Most experts recommend the Roth because of its several inherent advantages.

Far and away the preeminent advantage of a Roth IRA is that, upon reaching the retirement age, one can withdraw money without paying taxes on the gains. 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. Unfortunately, there is a downside to this as well. Later in life, when retirement arrives, you will be forced to pay taxes on the growth of your money. 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.

The major feature of both the Roth and Traditional IRA is that transactions within your account are not taxed. In a typical brokerage account, each transaction that has a gain is taxed. In the IRA you do not have to begin to think about taxes until your retirement (traditional) or never (Roth). When looking at a long period of time before you will need to withdraw the money, it is advised that you consider an IRA for your investment.

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. With the case of the traditional IRA once you are older than 70 1/2 years you will be forced to begin to take distributions or suffer a monetary penalty. In the case of the Roth IRA, however you are not required by law to take deductions at any age. In fact, you can continue to fund your Roth IRA (without withdrawing any money) until you are 100 if you so desire.

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. It is a simple matter of economics. 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. If you have more than 10 years before you are set to retire you may consider opting for a traditional IRA for this reason.

This sums of the key differences between the Roth and Traditional IRAs. 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.