Traditional IRA vs. Roth IRA Accounts

There are several types of Individual Retirement Accounts (IRAs) available in the United States. This article covers Traditional and Roth IRAs.

Retirement Accounts: Traditional IRAs

Traditional IRAs are private retirement accounts. In the United States, it is possible to receive multiple cash flows upon retirement. Wise retirement planning will lead to retirement income from government (Social Security), employer-sponsored retirement plans such as 401(k)s, and income from Individual Retirement Accounts. And perhaps even real estate, if any is owned.

When contributing to 401(k), tax benefits are gained as the amount contributed is before taxes. This principle applies to Traditional IRAs as well since tax deductions are possible, making these accounts tax-deferred. But, there are some limits for those in higher income brackets.

For details, check with a tax advisor and/or the Internal Revenue Service. The IRS provides a lot of useful information on its website. 

For 2017, individuals under 50 can contribute up to $5,500 to an IRA account, and those aged 50 and above are allowed to contribute $6,500. These limits get adjusted higher at times.

The amount allowed is also limited by taxable income. (There are exceptions for non-working spouses for whom contribution can be made by their husband or wife.)

For example, if taxable income happens to be $3,000, only that amount can be contributed to an IRA account. And not all compensation is eligible. Income from rentals, interest, dividends, pensions, annuities, and some partnerships is excluded.

Retirement Accounts: Roth IRA Accounts

Roth Individual Retirement Accounts offer a great opportunity to avoid paying some taxes at retirement.

When investing in Roth IRA, you can’t deduct your contribution, however, upon retirement, you won’t pay taxes on your gains within the Roth account.

What you’re allowed to contribute per year is $5,500 (as of 2017) and $6500 if you’re at least 50 years old. There are income limits for Roth IRA as those with higher income may not qualify to contribute at all, or be able to contribute only a portion of allowed limit.

The limits are different for singles and married couples. For singles, you can fully contribute to Roth if your income (calculated as Modified AGI) is $118,000 or less. There is a phase out (you can contribute less than maximum allowed) if your income is between $118,000 and $133,000 (as of 2017). After $133,000 income is exceeded, no Roth IRA contributions are allowed.

Married couples can make full contributions if together they made $186,000 or less, with a phase out between $186,000 and $196,000 (as of 2017).

If you’re not sure, always check with your accountant or IRS. Penalties will apply if you contribute while not allowed.

Investing in IRA accounts

When you open an IRA account, you self-direct your investments. However, not every investment is allowed. You can open an online brokerage account and purchase stocks, bonds, mutual funds, and exchange traded funds.

Forex trading is also allowed but you need to open an IRA forex account. Options are allowed but these need to be either covered calls or protective puts (basically, options on what you have in your IRA account). Futures can also be traded, however, that requires additional paperwork.

Certain precious metals investments also qualify and these include gold, silver, and platinum bullion and coins. Examples include American Eagle coins and bullion that is 99.9% pure.

Short-selling (which is borrowing stocks in order to re-purchase them later at a lower price, basically hoping for a decline) and margin (borrowing to buy more) aren’t allowed. Moreover, there are restrictions when it comes to collectibles and real estate.

In summary:

  • Traditional IRA: tax deduction now, pay taxes when you retire
  • Roth IRA: no tax deduction now, but no taxes when you retire

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Well-planned IRA investments will provide financial shelter during retirement years