Traditional IRA vs Roth IRA

Planning for Retirement

Individual retirement accounts, or IRAs, were enacted by Congress in 1974 as part of the Employee Retirement Income Security Act (ERISA).  IRAs are popular tax-deferred retirement plans that provide individuals with a method of investing their income and saving money for retirement.  As a licensed insurance agent, it is important to understand the benefits of each type of IRA.  Two types of IRAs include the ‘traditional IRA’ and a ‘Roth IRA.’

Traditional IRA

Simply known as an IRA, individuals and self-employed business owners have the opportunity to save money for retirement while receiving a current tax break.  As the amount contributed accumulates, it grows tax deferred until it is withdrawn at retirement.  Contribution amounts may be fully or partially deducted from current income, which results in a lower current income tax for the individual.

Any individual under the age of 70½ who has earned income can participate in an IRA.  Contribution levels allow up to 100% of an individual’s annual income, but cannot exceed contribution limits set each year by the federal government.  Any contribution that exceeds annual limits will be subject to a 6% “excise” tax.  Individuals who are 50 years or older are allowed to make “catch up” contributions that exceed normal annual limits.

 

Withdrawal from an IRA owner’s account must begin no later than April 1st following the year an individual reaches 70½ years old.  From this time on, a minimum amount must be withdrawn every year from the IRA to avoid a penalty tax on such difference.

If an individual withdraws IRA funds prior to reaching age 59½, the withdrawal will be viewed as income, and not only will it be taxed as income, it will also be subject to a 10% penalty fee because it is being withdrawn prematurely.  Exceptions to this penalty tax include withdrawals for a first-time home purchase, higher education expenses, or to cover qualified medical expenses.

Roth IRA

As a result of the Taxpayer Relief Act of 1997, the Roth IRA was created.  Roth IRAs work in an opposite manner to traditional IRAs in that they use post-tax dollars instead of pre-tax dollars for contributions.  They accumulate, build interest, and upon withdrawal, funds are not taxed.

While the maximum amount of annual contribution is the same as with a traditional IRA, a Roth IRA does not have restrictions on participant status if an individual is also covered by an employer’s plan, or already owns a traditional IRA.  Also, owners of a Roth IRA do not have to wait until they turn 70½ in order to begin withdrawals.  However, if an individual owns both a traditional IRA and a Roth IRA, his or her maximum annual contribution limit is considered to be collective for both types, not for each IRA.

Withdrawals from Roth IRAs can be either qualified, one of which that provides for tax-free distribution of earnings, or nonqualified, in which earnings are subject to tax.

Qualified withdrawals are allowed for individuals over age 59½, disabled individuals, or beneficiaries of IRA individuals who have died, though funds must be held in the account for a minimum of five years.  IRA funds can also be withdrawn without penalty for first time homeowners.

Nonqualified withdrawals are similar to traditional IRAs and the interest or earnings portion of the fund is taxed as income as well as assessed a 10% penalty tax for premature withdrawal.

The following two tabs change content below.
National Online Insurance School

National Online Insurance School

National Online Insurance School is a full-service life and health insurance education provider with services available to individuals and agencies nationwide. As a state-accredited insurance education provider, our courses satisfy state credit hour requirements and prepare you to take the state insurance exam.