There are many ways to plan for the future. Two financial vehicles, known as Roth IRA and Traditional IRA, are among the most popular options. There are a number of key differences between the two, including differences in contribution limits, early withdrawals, and how they’re taxed.
About Roth IRA
The principle of a Roth IRA is deciding not to accept the tax advantages of a conventional IRA. In exchange, you’re able to withdraw your money without having to worry about any taxes later on.
All you need to participate in a Roth IRA is proof of is “earned Income”. That’s it, unless you have “too much” earned income. The IRS in its wisdom says “if you earn too much” we will not allow you to put money into a Roth – exactly when you want to put money away for your future.
About Traditional IRA
The Traditional IRA is a tax deferred plan. You make contributions from your income before it’s taxed; by doing this, you lower the amount of income that’s presently taxable. Investors gain the advantage of growing their investment on a tax-free basis.
To qualify for this type of IRA, you must:
Be under the age of 70 and a half.
Have earned income.
Taxes have to be paid on any withdrawals because you don’t pay any taxes in the beginning when contributing to your IRA.
Benefits
The big difference between Roth IRA and Traditional IRA, in terms of benefits, is that to benefit from a Traditional IRA, taxes have to go down in future. That way, you can avoid paying higher taxes now to receive a more favourable tax rate later.
Roth IRA holders hope for the exact opposite because they pay tax immediately. If taxes go up in the future, they receive a more favourable tax rate.
Required Distributions, Withdrawals, and Contribution Limits
There are no required minimum distributions with Roth IRA.
Withdrawals can be made at any time without penalty because you it is a return of your principle.
Contribution limits are exactly the same for both. You can contribute $5,500 per year if you’re under 50 or $6,500 per annum if you’re over 50.
A Word on Early Withdrawals
An early withdrawal in finance is a withdrawal made if you’re under the age of 59 and a half. Withdrawals from Traditional IRAs are subject to a 10% penalty and taxes if withdrawn before you reach this age.
For most aspects of the Roth IRA, the tax has already been paid, so you won’t have to pay anything. If you’re withdrawing any earnings from it, you will be subject to the same tax and penalty fees as before because you haven’t paid tax on this income.
Here are some scenarios where you can have 10% of the penalty waived:
Paying for medical insurance premiums following redundancy.
If you’re permanently disabled.
If withdrawals are limited to $10,000 and used to refurbish, buy, or build a first home.
If you’re in the reserves.
Earned Income Limits
Another difference between Roth and Traditional IRA is how much you can deduct from your Traditional IRA and how much you can contribute to a Roth IRA. If your income falls below a certain amount, which changes depending on the year, you can deduct or contribute the maximum amount allowed.
But you can contribute to a Traditional IRA even if the amount you earn is higher than this annual limit. You just can’t make any further deductions. In the case of a Roth IRA, you can’t make any further contributions at all.
There are so many differences between these two IRAs. When deciding on which one is best for you, speak to your financial adviser first.
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.
The Roth IRA is a powerful investment vehicle. It has extremely good advantages, but it has its own set of limitations. So, let’s understand the pros and cons of a Roth IRA.
What are the Benefits of a Roth IRA
Listed below are the 8 advantages of the Roth IRA.
Your retirement income is tax-free.
Unlike traditional IRAs, your contributions towards your Roth IRA are taxed. So, the money in
Roth IRA grows free of tax. That’s not all – the distributions you take out from your account in retirement are also free from federal taxes and are likely to be free from the state as well as local taxes.
Your Roth contributions can be withdrawn any time
As you have already paid the tax, you can withdraw the contributions at any time. However, after 59 ½ both contributions and earnings can be withdrawn tax-free. This can give you a lot of added income when you’re no longer employed full-time. Think of Roth withdrawals as invisible money – not taxed and not a hindrance for Social Security, etc.
It does not make it mandatory for you to take the required minimum distributions.
Traditional IRAs and other employer-sponsored retirement saving plans have required minimum distributions (RMDs). That means, even if you don’t need the distributions, you have to take them because if you don’t, your income may be taxable.
With a Roth IRA, you don’t have to take RMDs.
It allows your money to grow uninterrupted and also enables you to pass on more of your retirement savings to your heirs.
Your heirs can enjoy tax-free money.
In inherited traditional IRAs and Roth IRAs, RMDs must be taken. However, in an inherited Roth IRA, RMDs remain tax-free.
It offers tax flexibility in retirement.
You can make contributions to both a Traditional IRA and/or a Roth IRA. Your total annual limits remain the same. Some financial planners encourage this strategy because it does give a slight tax break in income taxes today and tax-free income at retirement. Also, at retirement, you have a choice of which IRA to draw upon first.For example, at retirement, you can make withdrawals from your traditional IRA until your taxable income hits the top tax bracket. The additional money then can be taken from a Roth IRA.
You can contribute even after you turn 70 ½ years of age.
With a traditional IRA, you have to stop making contributions when you turn 70 1/2 years old. At this age, you have to take taxable distributions. Since Roth IRA has no restriction of RMDs, you can contribute even after you turn 791/2 years of age. That means anyone with earned income can keep on adding to their Roth IRA and enjoy the benefits of accumulated wealth when you are actually not having a source of earned income.
High earners can enjoy the benefits through a ‘back-door’ entry.
The IRS has set some income thresholds for high-income earners that limit the size of the contribution that can be made. If you are a high-income earner, you cannot make a direct contribution to a Roth IRAabove that threshold. But, you can still have the benefits of a Roth IRA by making a nondeductible contribution to a traditional IRA and then converting it to a Roth IRA.
What are the Disadvantages of Roth IRA
Listed below are the 4 disadvantages of the Roth IRA.
You pay taxes upfront.
Roth IRAs allow you to make tax-free withdrawals in your retirement. But the contributions you make now are taxable. If you are struggling with your savings, paying tax upfront for your Roth IRA contributions may put you at a disadvantage.
You may have income eligibility restrictions.
Not everyone is eligible to contribute to a Roth IRA. You aren’t eligible if your earned income and your modified adjusted gross income (MAGI) exceeds the annual contribution limits. These annual limits change each year.
You are charged penalties for early withdrawals.
Although you are allowed to withdraw your earnings from your Roth IRA early, you have to pay the penalty unless you are eligible for qualified distributions. To be eligible for qualified distributions, you should have your Roth IRA account open for at least five tax years, and you should have turned 59 1/2 years or are permanently disabled.
You may have a few investment restrictions.
With a Roth IRA, you may have a few investment restrictions. The funds from a Roth IRA cannot be used to invest in collectibles such as metals, gems, antiques, paintings, etc. You also cannot use the funds to buy a personal property. For example, you can’t invest in a house that you’ll use as a vacation home. On similar lines, you can invest your Roth IRA funds in businesses, but not your own.
There are pros and cons of Roth IRA contributions. You should seek the advice of a professional investment advisor to see which is best for you, and don’t forget this can change from year to year depending upon your personal circumstances.
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.
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.
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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.
The US Small Business Administration (SBA) released a report which highlighted a concern – only about a third of small or midsized business owners have an IRA. Even of this small majority, a further third were the only ones actually making contributions. 401(k) contributions are doing no better, with just 20% participating.
If you’re a business owner, you probably know better than anyone how difficult it is to set aside a fixed amount each time, but something is better than nothing at all. Here are a few investments options you can make use of to plan a comfortable retirement.
Below are the five small business retirement plans every small business owner must consider;
1. SEP IRAs
SEP IRA is a type of retirement plan that can be set up by employers, freelancers, sole proprietorships, partnerships and self-employed individuals. Contributions can only be made by the employer and are tax-deductible. Owner-employees contribute as both the employer and employee.
SEP IRAs are ideal for businesses without any employees, or very few employees.
Contribution Limits – The contribution limit for an SEP IRA account is 25% of the salary drawn, limited to a maximum of $56,000 and $57,000 in total contributions for 2019 and 2020 respectively.
Note – This IRA is fairly easy to establish, cheap to administer and offered by most online brokering firms, benefits consultants and other major financial institutions.
2. Simple IRAs
Like the SEP IRA, a SIMPLE IRA retirement plan can also be set up by employers, freelancers, sole proprietorships, partnerships and self-employed individuals. Eligible employees can contribute a portion of their pretax income to this plan. This means taxes on investments are deferred till the time they are distributed.
Simple IRAs are ideal for businesses with less than 100 employees.
Contribution Limits – The maximum contribution you can make to your Simple IRA is $13,500 for 2020 and an additional $3,000 in catch-up contributions if you’re over 50 years old.
Note – Simple IRAs are also easy to establish, and there are no compliance or testing issues to deal with. However, businesses with more than 100 employees are not permitted to use these accounts.
3. 401(k) Plans
401(k) plans are different from IRA accounts in many ways. Primarily, eligible employees can choose to make salary-deferral contributions (automatic salary reductions) on a pre or post tax basis. Employers can also make non-elective or matching contributions, or even add profit-sharing features. The earnings from the investments accrue tax-deferred.
401(k) plans are good for businesses that employ more than 50 people, but this varies depending on administration fees.
Contribution Limits – The contribution limits for 401(k) plans are $63,500 and $62,000 for 2020 and 2019 respectively, and an additional $6,500 and $6,000 in catch-up contributions if you’re over 50 years old.
Note – Administration fees for 401(k) plans can be in the range of several thousand dollars, but participants can take loans against their contributions, which makes them very attractive as an investment option.
4. Cash Balance Plans
Although cash balance pension plans are defined-benefit plans, they are maintained on the basis of an individual account, similar to defined-contribution plans. Employers credit a fixed percentage of a participant’s annual compensation to the account, along with interest charges.
Cash balance plans are ideal for professional services firms, or businesses whose employees have a high discretionary income.
Contribution Limits – The contribution limits are defined by the plan opted for and market rates.
Note – In cash balance plans, the employee’s account is credited with a pay credit each year, and an additional interest credit. This is usually a fixed or variable rate that is linked to a particular index. Market rates do not define the payout – rather, it depends on the benefits defined by the plan. Additionally, administration fees can be quite high.
5. Profit-Sharing Plans
Instead of a fixed or index-linked benefits plan, employers can also offer a profit-sharing plan, which gives the participating employees a fixed share in the profits earned by the company. These are also known as DPSP or deferred profit sharing plans. Many employers favor these for the increased employee-involvement in the business’ growth
Profit- sharing plans are ideal for most businesses with employees which are generating profits.
Contribution Limits – 25 percent of total compensation or $56,000 & 57,000 whichever is less for 2019 and 2020.
Note – Profit-sharing plans are limited to employer contributions, which are completely discretionary. The IRS form 5500 needs to be filled annually. These plans can also be offered alongside other retirement plans for employees of the company.
Rick Pendykoski is the owner of Self Directed Retirement Plans LLC, a retirement planning firm based in Goodyear, AZ. He brings over 30 years of diverse experience as a financial advisor. Rick takes great pride in giving honest and very experienced advice. Rick can readily converse with business owners and people looking to take control of their retirement accounts.
Most small business owners worry about financial security since they are not covered under an employer-sponsored retirement plan. However, with the improvements in IRA plans over the years, it has now become possible for small business owners to secure their life post-retirement with customized financial products.
Today, small business owners can invest in IRA plans that are designed to meet their unique requirements for the future, like:
SEP IRAs –SEP IRA is very similar to self-directed IRA and has many of the same features, but the difference is that it is more specifically designed for small businesses, with similar but bigger advantages. These accounts do not have any administrative costs for individual employees, and contributions can be made in the same way as any other IRA.
As with traditional IRAs, both of these accounts do not permit you to make withdrawals until you reach the age of 59 ½ years, with early withdrawals being subject to income tax as well as a 10% IRS penalty tax. You also need to start making RMDs (Required Minimum Distributions) when you reach the age of 70 ½ years, the same as with any other tax-sheltered retirement plan.
SEP IRA vs Self Directed IRA
Self-Directed IRAs and SEP IRAs share many advantages but have small differences that you should take into account. Let’s look at the advantages these IRAs share, to understand how they work:
They are Simple and Straightforward – Self-directed IRAs and SEP IRAs are some of the simplest types of IRA accounts you could invest in. To set them up, you just need to fill out the required paperwork and submit your contribution. They tend to work more like a normal bank account, with the only difference being that these are retirement accounts.
Tax-Deferred Retirement Savings – If you are making contributions to either IRA, then you do not have to pay taxes on that amount. This means you can save money on taxes right from the start. For example, if your income is $20,000 and you contribute $2,000, then you only have to pay tax according to $18,000. The earnings from these plans are also tax-deferred, for maximum financial growth.
You Can Pick your Custodian – Many employer-sponsored retirement plans include a specific trustee, which you cannot change. Due to the immense freedom afforded by a self-directed IRA or SEP IRA, you can choose your own custodian, picking one with the lowest fee or one whose services suit you the best.
Freedom of Investment Selection – Self-directed IRAs and SEP IRAs allow you control over the type of trustee you want, which also opens up more investment options. You can select a custodian with investment selections based on your particular requirements. Moreover, with this freedom, you can invest according your needs while enjoying the same tax advantages as a traditional IRA offers.
In addition, there are some specific advantages that each plan offers, which we’ll look at below:
Specific Benefits of Self-Directed IRAs
These Accounts are Highly Portable – A self-directed IRA is a completely “personal” oriented account, it stays with you where you want. You can transfer it between custodians and most importantly it can be rolled to employer-funded accounts if you choose to take a regular job instead of continuing with your business in the future.
They Offer Greater Protection – Self-Directed IRAs let you user real estate or precious metals to protect your investment from inflation and economic fluctuation. These accounts are very diverse and protect you from market volatility as well as growing your retirement savings.
Specific Benefits of SEP IRAs
No Tax Deductibility Limits – With other IRA accounts, you have limitations if your spouse also has an IRA plan, but with an SEP IRA, you will not lose deductibility on contributions even if your spouse has an employer-supported IRA. This type of IRA is designed specifically for you and your business.
High Contribution Limits – One of the greatest advantages of an SEP IRA is that it is not limited to $5,500 in contributions per year, and you can contribute much more if you’d like. The limit for an SEP IRA is 25% of your net income up to $53,000, and the percentage of income that you can contribute is almost 10 times higher than traditional IRAs.
Cover for Employees – Another major advantage with SEP IRAs is that if you own a business with employees working under you, then your SEP IRA can also be extended to cover your employees if they open up individual SEP accounts too. Other than the fact that this works as a great benefit for existing employees, it can also be a major plus point when you’re attempting to hire new ones.
There are many similarities between both these accounts, but the big difference is that you can make much larger contributions to an SEP IRA as compared to self-directed IRAs. Both plans offer many advantages for individuals and business owners, but an SEP IRA offers considerably greater benefits for those who own a small business.
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.
The common mistakes most of us make while saving for retirement is not calculating the rate of inflation and contingencies like long-term illness or accidents, which can drastically cut off your income flow.
The major reasons why our retirees are suffering from debt are a lack of planning and a prolonged economic crisis, which has drastically reduced job opportunities that they could try out post-retirement.
To eliminate the chances of such a scenario happening to you after retirement, take a few precautionary steps and the suggestions of an experienced financial advisor, which will ensure a debt-free retirement.
While planning for retirement, try to gauge your likely monthly income and expenditure during that period. Think how you will manage if by chance someone in the family falls seriously ill or has an accident. Seems depressing, but quite a possible scenario, will you have insurance to manage expenses?
On the other hand, do you have a tendency to go overboard with credit cards? Start curbing this habit once you are nearing the other side of forty as this will become a major cash burner after retirement. A recent report by Survey of Consumer Finances has stated that nearly 50 per cent of homes headed by a retired person have credit card related debt. If that does not scare you, then nothing will.
Is it better to paying off debt before retirement?
The answer is, take one step at a time. Below are the few things you should consider before you retire.
Is it better to pay off the mortgage or save?
If by the age of mid-forties, you have still not bought a house in any town or city, chances are you will never stay in a place too long. Do not waste your time in buying one now unless you can settle the entire amount before you retire. Staying in a rented or leased accommodation is no problem at all as several people live a tension free life about bequeathing the house after death.
Pay off all your loans before retirement
Honestly, do you want to enjoy time with your family and friends after retirement or work with banks and lending firms to slash debt? All of us will choose the former and hope to spend quality time lounging around with a book or catching up on favorite TV shows. Any financial advisor you talk to for suggestions on savings for retirement will advise you to sit with your banker or mortgage lender and start closing all your loans from the time you are fifty.
How to Improve your net worth?
Eliminating credit card debt and reducing your loans will improve your net-worth, though you may not get the income tax deductions. If at any time after your retirement you do need to borrow cash, this credit worthiness will help clear loans and give you the required cash when you really need it. The peace of mind you would get after getting rid of all loans cannot be ignored as it also improves the cash flow in the house.
Excited about clearing off all loans before retirement? Easier said than done, as getting the cash to do that can be really tough in a stagnant economy. However, do not lose heart and set milestones, which you can reach with minimal stress and tackle each loan one at a time to have debt free retirement.
Take help of your financial consultant to get rid of your debt if you are nearing your retirement.
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.
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