No wonder how healthy we might be but we all realize that one day we will grow old. Hence, we all know that we should plan our retirement such that we have sufficient money to support ourselves and our family in those last 2-3 decades of life. Most of us invest money in retirement plans like IRA. However, though there could be many common things among us there are also major differences in our income and lifestyle. Hence, an IRA which might be good for someone may not be the best fit for you. This article compares two of the most popular IRA plans; Traditional IRA and Roth IRA.
Traditional IRA can be taken by people only below the age of 70 and half years. So if you have already crossed this age threshold, then you should stop thinking of taking a Traditional IRA plan. Roth IRA however has no age limits.
In both Traditional and Roth IRA, to apply for one, you should be getting compensation. While calculating compensation, you can also include compensation received by your non-working spouse.
Both the plans have similar rules pertaining to Contributions. In both your contributions, including that of your non-working spouse cannot exceed your combined compensation.
Traditional IRA has no income limits. However, in Roth IRA for individual filers, income limit is set to $95,000. If you are filing jointly, then the combined income limit is $150,000.
$4,000 or 100% of compensation (whichever is less) per person per year is the contribution limit in both the plans. If you are above the age of 50, then there is a provision of “catch – up’ that you can use to increase your contributions. Under this provision, you can make limited additional contribution. This “catch up” contribution is set as $1000 for 2006.
Tax Advantage & Disadvantage
In traditional IRA, you Contributions can be tax deductible. That means you can deduct the contribution from your taxable income and hence save tax. However, in case of Roth IRA, contribution is not tax deductible. But the growth of the corpus is not tax free in Traditional IRA. And it is tax free growth in Roth IRA.
In Roth IRA, you can withdraw money anytime during the plan tenure. This is a great advantage as you get great assurance against future financial uncertainties. You can also withdraw anytime from a Traditional IRA. However, if the withdrawal is made before the age of 59 and half, you have to pay penalty. Penalty can be avoided only under circumstances. For example, if you are buying a house for the first time and if you satisfy certain other conditions, then you can escape getting penalized. Similarly, if you have to spend high on medical services or educational services, then you can do a penalty free withdrawal from your Traditional IRA. However, in this case your medical expense should be more then 7.5% of your annual income. There are a few more such clauses.
Both the IRA plans has their unique pros and cons. You would need to do an honest introspection and decide which plan to opt for. A wise choice can prove to be your backbone for the future.