by Tyler Townsend

Traditional IRA vs. Roth IRA

In an effort to encourage long-term retirement savings, the United States government has created various savings programs with nice tax benefits. However, it is not always clear which program makes the most sense for your family. Let’s take a look at two of the most popular savings programs with the goal of helping you decide the most effective way to save for your retirement.

The Traditional Individual Retirement Arrangement (IRA) allows the investor to contribute up to $5,000 per year ($6,000 if over age 50) into one or most designated accounts using different investment types such as stocks, bonds, mutual funds, CDs and cash. Assuming family income is below a certain level, the amount of the contribution can be deducted from income for tax purposes, providing an immediate benefit. For example, if a family has income of $75,000 and contributes $5,000 to a Traditional IRA, the family’s income taxes will be approximately $1,250 lower. This has the effect of contributing $5,000 for the price of $3,750! The investments grow without taxes on interest, dividends or capital gains as long as they remain in the IRA. In exchange for these benefits, the tax rules include a penalty for withdrawal prior to age 59.5, and at the time of withdrawal, the full amount is taxed as ordinary income.

The Roth IRA is similar to the Traditional IRA, but with an important distinction. While there is no immediate tax deduction for contributions, and assuming the money remains in the IRA until age 59.5, it is never taxed, even at the time of withdrawal! Unlike the Traditional IRA, which requires withdrawals beginning at age 70.5, money can remain in the Roth IRA indefinitely and even be passed to a loved one, who can also withdraw the money tax free.

From a purely mathematical perspective, it is impossible to know which type of IRA will wind up with the most money, since we can’t predict the tax rates at the time we will make withdrawals. Even with this lack of information, the Roth IRA is most often considered the preferred investment over the Traditional IRA. The benefit of taxfree withdrawals during the retirement years, particularly since we can’t predict future tax rates, as well as the chance to pass income-tax-free money to loved ones simply can’t be underestimated.

In concluding our discussion of IRAs, it is important to remember that your employer may sponsor a retirement plan. The decision of how much to invest in an employer plan before investing in an IRA has many variables and should be considered carefully. But one thing is clear—make sure you take full advantage of any available company match in the employer plan! Best wishes for your family finances!

Tyler Townsend is a Certified Financial Planner® with Townsend Personal Financial Planning in Columbus.

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