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Richard Chew – First Capital Insurance Group

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There are many types of IRA’s, but two of the most common are the traditional IRA and the Roth IRA.

The biggest difference between a traditional IRA and Roth IRA is their classifications in the IRS tax code. A traditional IRA holds the benefit of tax deferral, which means that money going into it has pre-tax status.

On the other hand, since a Roth IRA is funded with after-tax dollars, it gives the benefit of potentially tax-free distributions. On top of these differences, both types of accounts have different rules for distributions. Because of this difference and others, it is important to understand the fundamentals behind these two plans.

Income Limitations

People can open a traditional IRA and make contributions toward it if they received taxable compensation. Whether these contributions are tax-deductible will depend on the amount of income you earned and whether you, or your spouse, are covered by a workplace retirement plan.

Should your income exceed certain amounts, and one of you does have a retirement plan at work, your contributions may be limited. On the other hand, if neither of you is covered by a workplace retirement plan, you are permitted full deductions.

Roth IRAs come with no age restrictions. However, there are certain restrictions in terms of income.

If you are a single tax filer interested in contributing to a Roth IRA, your modified adjusted gross earnings in 2021 must be less than $139,000. In case of married couples, a modified AGI of less than $206,000 will qualify them for Roth contributions.

Tax Treatment Advantages

A traditional IRA helps you enjoy tax breaks while putting money into the plan. Roth IRAs helps you mitigate taxes when taking it out.

Traditional IRA contributions are deductible from state and federal income taxes for the year in which the contributions were made.

Withdrawals are subject to income taxation. That means your withdrawals are considered taxable income, and you will be taxed at the rate of the income tax bracket you fall into that year. State income taxes may also apply.

Roth IRAs don’t come with tax breaks. Contributions to them don’t reduce your gross income, and therefore your tax bill, in the year you make contributions. However, in general, your withdrawals are tax-free.

Differences in Withdrawal Rules

When you reach age 72, you must start taking certain minimum sums from a traditional IRA.

Roth IRAs, the account owner has no mandatory requirements to take any withdrawals during their lifetime.

Additional Benefits

Traditional IRA owners below age 59.5 can take up to $10,000 from their accounts, without paying a normal 10% penalty, for certain qualified expenses. These qualifying expenses include a first-time home purchase, higher education, disability, and certain kinds of unreimbursed costs.

Roth IRA owners are free to withdraw their contribution at any given time without paying any tax or penalty.