It is a smart move to start saving for retirement as early as you can because the earlier you start, the more years your money will have to grow before you retire. Many years of savings will give you a reserve that is large enough to see you through when you are no longer working.
Retirement accounts that are tax-favored are ideal places to put your retirement savings. Such plans or accounts are referred to as Individual Retirement Accounts or simply IRAs. The two common types of IRAs are the Traditional IRAs and Roth IRAs.
One difference between a Traditional IRA and a Roth IRA is the taxation of the contributions. While a Traditional IRA has tax-deductions on the contribution and payment of taxes on distribution, a Roth IRA does not offer tax-deductions for your contribution, but has qualified distributions that are tax-free.
Opening one of these accounts is good, but setting up the two of them gives you combined benefits and helps you increase your saving potential. Some of the tax related benefits you will enjoy if you have both a Traditional and a Roth IRA are outlined below.
Variation in Income
Higher benefits from contributions to a Traditional IRA do not always happen year in and year out. Some years will see you save more from a reduction in tax, but it is not the case when taxes are increased. If you have both a Traditional and a Roth IRA, you will be more flexible and contribute as needed.
Uncertain Future Taxes
It is difficult to predict how future taxes will look like, meaning it is tricky to choose between a Traditional and a Roth IRA. Having both of these accounts ensures that you play safe whatever turn the taxes take. As such, if tax rates shoot up, your Roth IRA will benefit from the tax-free distributions.
Should tax rates go down, your tax-deduction contribution to your Traditional IRA will win. Having both of these plans will help you reap from the best and favor taxes as at that time.
Flexible Retirement Distribution
Your tax bracket may change years into your retirement, and if you have both Traditional and Roth accounts, it will give you the flexibility to be able to choose either the taxable or the nontaxable distributions. In a year when the tax rate is higher, you can choose to take your Roth IRA distributions, and in a year when you are to pay lower tax rates, you can choose to take your Traditional IRA.
If you are not working for some time or are earning minimal income, then your tax bracket falls, and the Traditional IRA taxable distributions will be your better option. On the other hand, if your income rises and your tax bracket changers, this will make the tax-free distributions from a Roth account of more value to you.
Early Withdrawal Options
A holder of a Roth account is advantaged in that he or she is able to withdraw his or her contributions at any time and with no penalties. A Traditional IRA holder will be slapped with a 10 percent penalty tax on any withdrawals made earlier than the qualifying age.
If you have the two accounts and the need for a withdrawal arises, you can comfortably do so without any extra expenses in terms of the penalty. By withdrawing from your Roth IRA, you will escape the penalty from your Traditional IRA.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning company based in Goodyear, AZ. He has over three decades of experience working with investments and retirement planning, and over the last ten years has turned his focus to self-directed ira accounts and alternative investments. If you need help and guidance with traditional or alternative investments, call him today (866) 639-0066.