Roth IRAs vs. Traditional IRAs: For Filing Taxes and Your Retirement

This is a guest post from Kellie Englehardt, she sent me this post yesterday and asked if I accepted guest posts. After reading this and gauging its usefulness for your tax return, I decided to publish immediately. 

I sincerely hope at least some of my readers would definitely find it useful. usually I do not post on Thursdays, making an exception today. Enjoy and learn the following.

This year, taxes are due April 17, less than a month away. With the deadline quickly approaching, many people are wondering how they can cut their tax bill. One thing you can do, according to the IRS, is contribute to an IRA. A contribution will not only reduce your taxable income, but it will generate retirement savings as well. It’s a win-win situation.

The great thing about IRAs is that if you contribute before the tax filing deadline, the contribution counts toward your taxes.

But that is no secret. In fact, Fidelity Investments estimates that 50 percent of all IRA contributions are made within 28 days of the tax filing deadline.

“March is an excellent time to contribute to an IRA,” said Derek Overstreet, president of New Millennium Insurance Services in South Jordan, Utah. “Would you rather give your money to Uncle Sam or put it toward your future retirement savings? An IRA is one of the best ways to invest in your future.”

IRA accounts are especially popular because they grow tax free if you have the account for a minimum of five years and are at least 60 years old.

By now you’re probably wondering how to take advantage of this investment strategy. However, before rushing out to open an IRA there are three factors you should consider when choosing and setting up an account.

Traditional vs. Roth IRA Accounts

1.   Tax Benefits:  The first choice you need to make when setting up an IRA account is whether to open a Roth or a Traditional.  Traditional IRA contributions go in tax free, and are taxed when you withdraw the money for retirement.  Roth IRAs are the exact opposite, and therefore do not reduce your annual taxable income upon contribution.

2.   Age:  Both Roth and Traditional IRAs have the same $5,000 maximum contribution ($6,000 if you are older than 50). However, a Traditional IRA does not allow you to make contributions once you reach age 70.5, whereas there is no age limit for Roth IRAs. Traditional IRAs mandate that you start taking the required minimum distribution by age 70.5. Roth IRAs do not have any required minimum distribution rules.

3.   Income:  Roth IRAs do have income restrictions depending on your filing status.  Once your income exceeds this limit, you are prohibited from making contributions to your Roth IRA. Traditional IRAs do not have these restrictions.

Both Roth and Traditional IRAs do not allow you to make contributions that exceed your annual income. Therefore, if you made $3,000 for 2011, you can only contribute $3,000, not the maximum $5,000.

The return on an investment into an IRA account can be substantial. For example, putting away $5,000 a year for 20 years with a total contribution of $100,000 and an 8 percent average return could yield $247,000.

Roth IRAs tend to be the most popular IRA account, and experts recommend setting them up and contributing to them on a regular basis.

“Roth IRAs are definitely the way to go if you can meet the income requirements and don’t mind giving up the tax deduction in the beginning,” said Overstreet.  “They offer much more freedom and flexibility in the long run. Open them as soon as you can, and contribute to them as long as you can.”

A retirement planning expert like New Millennium can help you prepare for retirement by alerting you to various tax options and identify your retirement planning needs.

“A Roth IRA gives individuals a chance to diversify their investments. Those who make investments within a 401(k) may also invest in an IRA. It may even be a great opportunity to make up for a retirement contribution you hoped to make in the past,” said Overstreet.

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