Understanding IRA’s and Roth IRA’s
This is Part 4 of a 9 part series focused on educating others on retirement accounts, alternate means of investing with these accounts, and ultimately how we can provide multiple forms of investment opportunities with these accounts within our business in which you can attain high rates of returns at substantially low risk.
It can be a bit overwhelming for individuals, not very savvy with the concept of personal investing, to know and understand the basic types of retirement accounts (we prefer to call them “wealth building tools”) available to initiate on their own. However, figuring out the math (at least the basic fundamentals) is not as complex as it seems to be. Basically, there are two types of Individual Retirement Accounts (IRA’s) – a traditional IRA and a Roth IRA.
If you dig deeply into the benefits and restrictions, you could come up with a long list of differences between the two of them but the primary ones are about taxes, withdrawal restrictions, income limits (i.e. how much you can contribute based on your “earned” income), and mandatory withdrawals.
If you have a traditional IRA, the money grows tax-free irrespective of how much income your IRA investments earn while within the plan. Your distributions are then taxed when you retire and start to make withdrawals from the account. Also, the money you contribute to the traditional plan is not taxed. The amount of your contribution is removed from your taxable income during your annual tax filing for the year of your contribution. Often this results in an overpayment in taxes allowing you a credit or refund.
Traditional IRA’s impose a minimum withdrawal amount, known as required minimum distributions (RMDs), once you do start to take distributions. They also require you to take mandatory withdrawals at the age of 70-1/2 if you have not yet begun to do so. Allowing your wealth to grow tax free is a very powerful tool however, one must be mindful of the amount they wish to live off of during retirement as they may find themselves in a much higher tax bracket in retirement.
Roth IRAs provide no tax break for contributions, but earnings and withdrawals are generally tax-free. Anyone with an earned income, who is younger than 70 ½, can contribute to a traditional IRA. Roth IRAs, however, have income-eligibility restrictions, for both single tax filers and joint tax filers.
Roth IRA’s allow an individual to withdraw their contributions from the plan at any time with no penalty. However, earnings cannot be withdrawn from the plan without penalties until the age of 59-1/2 and the earnings withdrawn must be properly seasoned (i.e. are a result of a contribution having been made at a minimum of 5 years earlier).
Another great feature of a Roth IRA is you do not have to make a withdrawal, ever. Simply put, if you want to create a pot of wealth for your loved ones after you are gone, this plan allows you to refrain from taking contributions and is not taxed upon your death. That means essentially that everything you put in the plan is there until your death and is provided, in full, to your heirs after your death.
One last point of mention, both plans require you to have an earned income (i.e. wages, salaries, tips, bonuses, commissions, and self-employment income) rather than a passive income (i.e. interest and dividends from investments, income from rental property, and pension payments). This may seem obvious to most but it is a point worth making. Everyone’s situation is different.
Be sure to keep following this series as we help bring all this information together to show you how working with us and knowing how to take advantage of these tools can optimize the growth of wealth for your future.