An Individual Retirement Account (IRA) is a powerful and flexible tool for individuals looking to save for retirement. These accounts can be opened directly with banks or brokers, providing a flexible option outside employer-sponsored plans. The two most common types of IRAs are the Traditional IRA and the Roth IRA. Similarly, many employers offer 401(k) plans in both Traditional and Roth versions. While both account types aim to help individuals save for retirement, they differ significantly in their tax treatment and withdrawal rules.
Traditional IRA vs. Roth IRA: Key Differences
Tax Treatment:
- Traditional IRA: Contributions to a Traditional IRA are made with pre-tax dollars, which means you can deduct these contributions from your taxable income for the year. The funds grow tax-deferred, meaning you pay taxes on them only when you withdraw the money during retirement.
- Roth IRA: Contributions to a Roth IRA are made with after-tax dollars, which means you pay taxes on the money before it goes into the account. However, the funds grow tax-free, and withdrawals during retirement are also tax-free.
Contribution Limits:
- Traditional IRA: For the tax year 2024, individuals can contribute up to $7,000 annually. Those aged 50 and above can make an additional catch-up contribution of $1,000, bringing the total to $8,000. This catch-up contribution is a special provision that allows older individuals to save more for retirement, recognizing that they may have less time to build their retirement savings.
- Roth IRA: The contribution limits for a Roth IRA are the same as for a Traditional IRA. You can contribute up to $7,000 annually or $8,000 if you are 50 or older.
Withdrawal Rules:
- Traditional IRA: Withdrawals from a Traditional IRA before age 59½ are generally subject to a 10% early withdrawal penalty and taxed as ordinary income. After age 59½, withdrawals are taxed as income but without the penalty. At age 73, account holders must start taking required minimum distributions (RMDs).
- Roth IRA: Contributions (not earnings) can be withdrawn from a Roth IRA at any time, tax and penalty-free, provided the account has been open for at least five years. No minimum distributions are required for a Roth IRA, allowing for more flexible retirement planning.
Choosing the Right IRA for You
Consider your current and expected future tax brackets as a key factor when deciding between a Traditional and a Roth IRA. A Traditional IRA may be more beneficial if you anticipate being in the same or a lower tax bracket upon retirement. Conversely, a Roth IRA could be advantageous if you expect to be in a higher tax bracket in the future, as it allows for tax-free withdrawals.
Choosing the right retirement account is crucial for optimizing your financial future. Whether you opt for a Traditional or Roth IRA, understanding the differences in tax treatment, contribution limits, and withdrawal rules will help you make an informed decision. Consider consulting with a financial advisor for personalized advice tailored to your unique financial situation.
We thank the Wisconsin Bankers Association and the Wisconsin Bankers Foundation for providing this valuable content. Their expertise and dedication to financial education play a crucial role in helping individuals make informed decisions about their retirement planning. Thank you for your continued support and commitment to empowering consumers with the knowledge they need for a secure financial future.
If you are a Legacy client and have questions, please do not hesitate to contact your Legacy advisor. If you are not a Legacy client and are interested in learning more about our approach to personalized wealth management, please contact us at 920.967.5020 or connect@lptrust.com.
This newsletter is provided for informational purposes only.
It is not intended as legal, accounting, or financial planning advice.
