There is no easy answer to this question. An individual retirement account (IRA) is a personal savings plan that offers specific tax incentives to encourage you to save for retirement. Currently, there are two types of retirement IRAs, Traditional IRAs and Roth IRAs, and they share certain general characteristics. Both feature tax-deferred growth of earnings and allow you to contribute up to $5,500 in 2017 (unchanged from 2016) of earned income, plus an additional $1,000 “catch-up” contribution if you’re 50 or older. Both allow certain low- and middle-income taxpayers to claim a partial tax credit for amounts contributed. But important differences exist between these two types of IRAs. In fact, the Roth IRA is in some ways the opposite of the Traditional IRA.
- Traditional IRAs: Allow anyone with earned income who is under age 70½ to contribute the maximum $5,500 in 2017, plus catch-up if eligible. However, your ability to deduct traditional IRA contributions will depend on your annual income, your filing status, and whether you or your spouse is covered by an employer-sponsored plan. You may be able to deduct all, a portion, or none of your contribution for a given year.
- Roth IRAs: No age limitation applies to contributions. As long as you have taxable compensation and qualify, you can contribute to a Roth IRA even after age 70½. However, the amount you’ll be able to contribute (up to the annual limit) will depend on your income and tax filing status. Although Roth IRA contributions are not tax deductible, Roth IRAs have other advantages. Your ability to contribute does not depend on whether you or your spouse are covered by an employer-sponsored retirement plan. The fact that one of you is covered by such a plan has no bearing on your allowable contribution to a Roth IRA.
- Distributions: A withdrawal from an IRA is referred to as a distribution.
- Any distribution from a Traditional IRA will be subject to income taxes to the extent that the distribution represents earnings and deductible contributions. You may also be hit with a 10 percent early withdrawal penalty if you draw money out before age 59½ (there are exceptions to this rule). Beginning at age 70½, you must begin to take annual distributions from a Traditional IRA.
- You’re not required to take distributions from a Roth IRA at any age, which gives you more estate planning options. Qualified withdrawals will avoid both income tax and the early withdrawal penalty if certain conditions are met. Non-qualified withdrawals will be taxed and penalized only on the earnings portion of the withdrawal, since the principal is your own after-tax money.
Your personal goals and circumstances will determine which type of IRA is right for you. If you wish to minimize taxes during retirement or preserve assets for your heirs, a Roth IRA may be the way to go. A Traditional IRA may make more sense if you can make deductible contributions and want to lower your taxes while you’re still working. For more information about IRAs, contact Scott Brady at 248.443.4234.
Advisory Services offered through Capital Asset Advisory Services, LLC, a Registered Investment Advisor. Michigan First Credit Union is not affiliated with Capital Asset Advisory Services, LLC.