Here are differences between a Roth IRA and a traditional one
My last column explained the features of a traditional IRA. This one will focus on details of a Roth IRA.
This IRA was named after William Roth, a former Delaware senator, and was established by Congress in 1997. It is a tax-advantaged retirement savings account that allows you to withdraw savings tax-free.
The biggest difference between a Roth and a traditional IRA is how and when you get a tax break. The tax advantage of a traditional IRA is that your contributions are tax-deductible in the year they are made. The tax advantage of a Roth IRA is that your withdrawals in retirement are not taxed.
The next important difference is no RMDs. My last article explained that traditional IRAs require you to start taking required minimum distributions (RMD’s) when you turn age 72. You never have to take your Roth IRA money.
The maximum annual contribution is the lesser of $6,000 ($12,000 for a married couple) or 100% of compensation. A separate spousal Roth IRA may be established for a spouse with little or no earned income.
The maximum annual contribution to a Roth IRA is phased out for individuals with incomes in excess of certain limits. For 2019, the maximum contribution to a Roth IRA is phased out for single taxpayers with modified adjusted gross income between $122,000 and $137,00. For married couples filing jointly, the phase-out range is a MAGI of $193,000 to $203,000.
Roth IRAs may be opened anytime between Jan. 1 of the current year until the due date of the tax return. The account is usually self-directed (owner controls investments).
Qualified distributions are tax-free if a five-year holding period is met and one of the following applies: the owner is over 59 1/2, dies, becomes disabled or the distribution is for up to $10,000 of qualified first-time homebuyer expenses.
At death, the value of a Roth IRA is included in the owner’s federal gross estate. If the five-year holding period is met, beneficiaries receive funds free of federal income tax. A surfing spouse may choose to treat an inherited Roth IRA as his or her own.
A traditional IRA can be converted to a Roth IRA, but the distribution will create a taxable event. Individuals can have a Roth IRA and a traditional IRA, but must coordinate the maximum annual contribution limits.
Understanding that Social Security was intended only to provide a quarter of our retirement income, the importance of providing additional retirement income has never been greater.
Roth IRAs can be opened at a bank, brokerage firm or an insurance company. Choosing the type of investment you are comfortable with also may help you decide which IRA (Roth or traditional) is best for you. If finding funds for your IRA may be difficult, then a traditional IRA with a current tax break may be the correct choice.
If you can fund your IRA now then the tax break at the end, a Roth IRA may be best for you. Also, look at your tax rate. Lower wage owners may want to sacrifice the now tax break for the one later in life, when their tax rate may be higher. Understand that you may have both IRAs and choose funding one over the other because of your financial situation, extra money or increased income with higher taxes.
Start your IRA today and understand the rule of compound interested. A small contribution every year is better than large contributions 20 years from now. We know in my office that successful savers have a plan, and they budget $100 or $500 every month.
As always, get tax advice from professionals and be careful how you fund your investments.
Bob Hollick is a State Farm Insurance agent based in Washington.
To submit columns on financial planning, investing or business-related matters, email Rick Shrum at rshrum@observer-reporter.com.