Advantages & Disadvantages of Traditional & Roth IRAs
When discussing IRAs, there are multiple types to look over and review to decide which one best fits you and your company. We’ve already gone over some things about Traditional and SEP IRAs and will now be delving into Traditional and Roth IRAs.
Both of these IRAs can be beneficial retirement accounts, and almost anyone can use them, depending on their income, making them very versatile. Any retirement account has tax advantages and disadvantages, depending on how you need or want to use them – Traditional and Roth IRAs are no exception.
The Benefits & Differences
The most significant benefit of a Traditional or Roth IRA over the other retirement accounts we’ve reviewed is that you have until April 15th to make your final contribution to them. This means that you have time to work on your taxes and gather your documents to figure out what your actual tax liability will be, then decide on how much to invest into your Roth or Traditional IRA to give you the best tax advantage.
Now, let’s get into the differences between these types of accounts and review the advantages and disadvantages of each, starting with traditional IRAs. These are considered deferred tax accounts, and what you’re doing is taking whatever money you put into it today and deferring the tax liability on that account to the future. When doing tax-deferred accounts, it will save you whatever percentage or bracket of taxes you would fall into in the year you file.
Also, the money you put into this account will be invested until you retire. Depending on how old you are when you start your investment, you can have the money sitting there for 5, 10, 20, 30, or even 40 years. That money will grow, and you will gain additional funds to retire on.
While this is true of just about any retirement account, with tax-deferred accounts, such as Traditional IRAs, when you either take all that money out or start taking draws from that retirement account, it will tax all the money pulled out. This includes any gains that your account has created along the way.
It may sound counterproductive, but the goal of a Traditional IRA is to help you avoid additional taxes now and pay the taxes later when you should, theoretically, be in a lower tax bracket come retirement so that you’re not paying as much in taxes overall.
If you’re currently in the 10 or 12% tax brackets, Traditional IRAs may not make the most sense because you’re not in a super high tax bracket. With the 22 and 24% tax brackets, these could benefit you, depending on how much money you need or feel you’ll need a year while in retirement. Suppose you’re currently in one of these brackets and will be in them when you retire.
In that case, there’s no tax savings in using a Traditional IRA, as you’ll essentially defer that tax to retirement rather than paying it all upfront. While this is still a viable option, there are smarter ones if you’re going to be in a similar or higher tax bracket in retirement that can help you save on taxes.
If you’re currently in the 10-12% bracket and possibly looking at going to the 22-24% tax bracket, putting your investments into a Roth IRA could be the road you’d want to take. With a Roth IRA, you’ll be paying taxes on the money that you put into it today.
However, you won’t be paying taxes on that or any of its gains while invested when you take it out for retirement. This makes it very important to understand your current tax position along with understanding what your future tax position may be so that you know if Traditional or Roth will help maximize your investment and tax savings.
As we’ve mentioned previously, deciding on which retirement plan to go with involves talking with a money advisor, an investment person who can walk you through and discuss your retirement needs more in-depth. They will also be able to guide you on a tax-saving strategy, as they know the markets and are familiar with setting up these accounts and planning for retirement with their clients.
Limits to Contributions
Another thing to remember for both Traditional and Roth IRAs is the limit to which you can put in or the amount of money you can put into them in a given year.
For 2024, if you are under the age of 50, you can put in a maximum of $7,000 combined between the two. You could do $3,500 into one and $3,500 into the other, or $6,000 into one and $1,000 into the other, or do $7,000 into one and $0 into the other, but you cannot put $7,000 into a Traditional and $7,000 into a Roth.
If you’re over the age of 50, you have the option to do what’s called a catch-up contribution, which is an additional $1,000 for 2024. The IRS adjusts These limits each year, so you’ll want to check their website each year to maximize your retirement contributions
The one thing that we see overlooked most often is that you may be ineligible to contribute to a Traditional or Roth IRA depending on your level of income and if you’re covered by a retirement plan at work. If you’re covered through work, it may eliminate you from being able to contribute to a Roth IRA. For example, if you’re a single filer and file single or head of household in 2024, and you make over $87,000, you cannot contribute to a Traditional or Roth IRA.
If you do, when you file your taxes, they’ll tell you that you’ve got to pull the money out, or you’ll get penalty taxes on the money you’ve put into it. If you’re married, filing jointly, and you are covered by a retirement plan at work, meaning that you have the option to participate, not that you are participating, and you make more than $143,000, you won’t be able to contribute to either a Traditional or a Roth IRA. There are also income ranges where the deduction gets limited.
For married individuals between $123,000 and $143,000, you will have a reduced amount that you can be traditional ira contributions or roth ira contributions. In instances where a retirement plan at work covers your spouse but you aren’t covered at work, you’ll still be able to contribute so long as your household income does not exceed $230,000. However, if your household income is more than $240,000, you cannot contribute.
If you’re in lower income ranges, such as below $100,000, there are fewer regulations and rules there, and it’s really easy to do many things on your own and use software like TurboTax or H&R Block to help you finish everything. But if you were in the higher $100,000 to $150,000 range and you’re married, it can lead to some differences in what’s allowed for you versus others in the tax code.
You’ll want to review the limits on contributions for your income bracket when looking into retirement accounts.
When looking into any retirement account, it’s also essential to research the age at which you can start drawing from the account. Once you turn 59 ½, you must begin drawing for Roth IRAs. You won’t be able to wait until later to start drawing, but you also won’t be able to draw anything from the account before then.
If you begin drawing money and do not fall under an exemption , you will be taxed on the money that you withdrew as ordinary income, along with paying an additional 10% tax penalty.
This is in addition to the taxes you already paid when investing the money into the account. It’s similar for Traditional IRAs. You can’t withdraw before turning 59 ½. Otherwise, you will pay the income taxes and a 10% early withdrawal penalty.
However, you don’t have to start drawing at 59 ½ with a Traditional. You can wait and let the account continue to grow until you reach the age of 73, at which time you’ll be required to start taking minimum distributions.
Which Way Should You Save for Retirement?
All of these things are important to keep in mind and are also why; again, it’s important to talk to a professional so that you can be sure that you’re making the smartest decision for you today while planning for your life 10, 15, 30, or 40 years down the road. In the future, you will thank the you of today for taking the steps to provide for yourself in retirement.
If you need more assistance or if you have any other questions regarding your retirement, feel free to reach out to us here at Waterford Business Solutions. We’re happy to work with you and discuss how retirement can affect your taxes today and in the future. While we can’t help you with the physical investments, we’re happy to help you with the tax side and refer you to one of our multiple investment partners. You can give us a call at 864-351-0852 or shoot us an email at info@waterfordbusiness.com.
Check out our youtube video How Traditional And Roth IRAs Can Save You On Taxes with James to give you a first hand recap.If you are still determining which plan works best for you or need additional help or have any questions, Waterford Business Solutions is happy to help.
