When you retire and start drawing money from your investment accounts, do you anticipate that your tax rate will be higher than it is right now? If you answered “yes,” consider choosing a Roth IRA. In the future you’ll likely be moving to a higher rung of the income ladder, and since withdrawals from a Roth IRA are tax-free, your future flush self won’t owe the IRS when you start drawing income.
Roth vs Traditional: How Should You Choose?
If you answered “no,” a traditional IRA may be a better choice. High earners tend to migrate to lower tax brackets upon retirement, so can it make sense for them to take the up-front tax deduction these accounts offer during their working years — and absorb the income tax hit down the road in retirement when their tax rate is lower.
Have no idea how your future tax rate will compare to your current one? Consider splitting the difference: Contribute to both a traditional IRA and a Roth IRA in the same year, which the IRS allows as long as the total amount you sock away is within allowable limits.
How Can I Get Started?
As long as we’re on a roll, let’s address two final obstacles that keep savers on the sidelines instead of jumping in and reaping the major benefits of setting up an IRA:
- See if you earn too much money (in the IRS’s opinion): Your income is the key factor in determining:
- a) if you’re eligible to contribute to a Roth (partially, fully or at all); and
- b) how much of your contribution to a traditional (or regular) IRA you’re allowed to deduct from this year’s taxes.
- Decide where to open an account: The best way to narrow the vast field of contenders is based on how hands-on you want to be: DIY types who prefer to manage the investments on their own should focus on discount brokerage firms. Here’s who we deemed top IRA providers for 2018 based on our research.
If you’re more comfortable with an automated service that determines the best investment mix for you based on your goals, then consider a robo-advisor.
Still unsure? 4 More Key Differences:
That hits most of the high points of how Roth and traditional IRAs work and which one best fits your needs. But beyond the abridged Roth-versus-traditional-IRA discussion, here are deeper dives on the four key ways these accounts differ from each other:
- Taxes,
- contribution limits,
- early withdrawal rules and
- required minimum distributions.
Taxes and the Two
The biggest difference between a Roth and a traditional IRA is how and when you get a tax break:
- The tax advantage of a traditional IRA is that your contributions are tax-deductible.
- The tax advantage of a Roth IRA is that your withdrawals in retirement are not taxed.
In other words, with a traditional IRA, you pay taxes when you take distributions in retirement (or if you make withdrawals prior to retirement).
A Roth IRA operates in reverse: You pay taxes upfront, because your contributions are not deductible. Earnings on your investments grow tax-free in a Roth and tax-deferred in a traditional IRA.
Contribution Limit
Both traditional and Roth IRA’s come with eligibility rules and restrictions that determine how much you can contribute. Assuming you’re eligible for both, you can contribute to a traditional and a Roth IRA during the same year, as long as the total amount does not exceed the maximum allowable contribution limit of $5,500, or $6,500 if you’re age 50 and over.
The amount you’re allowed to contribute to a Roth IRA, however, isn’t an all-or-nothing scenario — it’s a “heck, yeah!” “sorta” and “sorry, not this year, cowboy” scenario.
Roth contribution limits are based on household income, and those at higher incomes often find themselves squeezed out of Roth eligibility either partially or completely. (See our Roth IRA Contribution Limits page for details on how much your income will allow you to contribute.)
There are no income restrictions for contributing to a traditional IRA’s — titans of industry and everyday workers alike are eligible to open and contribute up to the annual limit — but your income can affect how much of your IRA contribution you’re allowed to deduct from your taxes.
In addition to the size of your paycheck, traditional IRA deductibility takes into account tax filing status and whether you and/or your spouse are covered by an employer’s retirement plan. For details on how this is calculated, see our page on Traditional IRA Contribution Limits.
Early Withdrawal
It’s generally not a good idea to withdraw money from an IRA early, and the rules do a good job of deterring it: You must be at least age 59½ to avoid early withdrawal penalties and taxes. But sometimes dipping into your retirement savings is unavoidable.
When you take money out of a traditional IRA before retirement, the IRS socks you with a hefty 10% early-withdrawal penalty and taxes the money you take out as income at your current tax rate.
The Roth has better terms for those who break the seal on the retirement savings cookie jar: It allows you to withdraw contributions — money you put into the account — at any time without having to pay income taxes or an early withdrawal penalty.
However, there are different rules when it comes to accessing the earnings from your Roth IRA: That money is subject to the five-year rule that states that any earnings withdrawn before your first Roth IRA contribution is at least 5 years old may be subject to income taxes and a 10% early withdrawal penalty.
Minimum Distributions
Fast-forward to your 70th birthday. Six months after you blow out the birthday candles you’ll be subject to required minimum distributions (RMD’s) from your traditional IRA. Remember, the IRS is still waiting to tax that money it has left alone for so long. Taking RMD’s is not a big deal if you’re retired at age 70½ and are already living off your retirement savings.
But if you’re a financially flush member of the silver-haired set who doesn’t necessarily need to withdraw funds from the IRA, the requirement is less appealing. Not only will you have to interrupt the growth of what’s in your account by making withdrawals, but if you’re still working and want to contribute more to a traditional IRA, you’re out of luck. No additional contributions are allowed after age 70½.
For those who live long and continue to prosper, the Roth is less stringent: It has no required minimum distribution rules. You’re free to let your savings stay put in the account and continue to grow tax-free as long as you live.
You’re also allowed to continue contributing to a Roth past the age of 70½. If you’re fortunate enough to not need to tap into the account for income right away and you want to pass on a larger account to your heirs, Roth is the way to go.
When a Traditional IRA Makes More Sense
When you have no other retirement plan — If you have no other retirement plan, then your contributions to a traditional IRA will be fully tax deductible, regardless of income. This is especially beneficial if you are in the higher income tax brackets — say, 24% or higher.
When the IRA is tax deductible, even if you’re covered by another plan — Even if you’re covered by another retirement plan, you can still deduct a traditional IRA contribution if your income does not exceed certain limits. For 2018, singles can earn up to $63,000 per year and still deduct the full amount of the contribution. The deduction phases out between $63,000 and $73,000, after which none of it will be deductible.
If you’re married filing jointly, you can earn up to $101,000 and still deduct the full amount of the contribution. The deduction phases out between $101,000 and $121,000, after which none of it will be deductible.
When your income exceeds the limits for a Roth IRA — With a traditional IRA, you can make a nondeductible contribution even if your income exceeds the income limits. But when it comes to a Roth IRA, once you reach the income limits, you can’t make a Roth contribution at all.
In that situation, it makes sense to make a nondeductible contribution to a traditional IRA. It will increase your retirement funding overall and still allow your investment income to accumulate on a tax-deferred basis.
When a Roth IRA Makes More Sense
When you’re interested in creating tax diversification within your retirement plans — Traditional IRA’s are tax-deferred with respect to both contributions and accumulated investment earnings. Roth IRA’s, however, are tax free if you are at least 59½ at the time you make the withdrawals and the plan has been in existence for at least five years.
In this way Roth IRA’s provide you with income tax diversification. While distributions from other retirement plans become taxable upon withdrawal, your Roth IRA funds come to you completely free from federal income taxes. It’s an excellent strategy, especially if you will continue to be in a relatively high marginal income tax bracket in retirement.
When you want to preserve your money past age 70½ — We’re talking again about required minimum distributions (RMDs) here. They kick in at age 70½, and they apply to virtually every retirement plan except for the Roth IRA. Simply put, once you reach that age, you’re required to begin taking distributions based on your remaining life expectancy.
Since Roth IRA’s have no RMD’s, you can build your investment virtually for the rest of your life. This is an excellent way to continue accumulating retirement assets so that you don’t outlive your money. The Roth has better terms for those who break the seal on the retirement savings cookie jar: It allows you to withdraw contributions — money you put into the account — at any time without having to pay income taxes or an early withdrawal penalty. It’s also an excellent way of preserving more of your estate to pass on to your heirs. Only a Roth IRA can do that for you.
If your income tax liability is either low or nonexistent — Even if you can make a deductible traditional IRA contribution, it may not make sense if you have no income tax liability or if you’re in the 10%, 12% or 22% marginal tax rate bracket.
Since Roth IRA money can be withdrawn completely free from income taxes, it is a superior retirement plan to a traditional IRA. The last thing that you should want to do is trade a 10% tax savings now for a potentially higher tax rate on withdrawals in retirement, which is exactly what you’ll do if you make a contribution to a traditional IRA.
If you think you may need access to the money before retirement — Since there is no tax deduction from making a Roth IRA contribution, the amount of the contribution can be withdrawn free from income taxes and penalties, even if the withdrawal happens before you turn 59½. Not so with a traditional IRA if the contributions were tax deductible when made. So if you think you may need the money before retirement, the Roth IRA should be your choice.
A Third Option
Even though they’re both IRA’s they have so many different provisions that how and when you use them will also be different. So before opening a new account or creating a new retirement plan, consider both types and their effects.
If both seem applicable to your potential situation, there is a third option: You can hedge your bets and maintain both a traditional IRA and a Roth IRA. That way, you’ll be prepared for whatever tax situations come your way.
Conclusion
Start by looking at your income. There are income limits for Roth IRA’s, so if your income is above those limits, then it’s a no-brainer: a traditional IRA is the only one for you. Let’s say you’re eligible for both a Roth and a Traditional IRA:
Generally, you’re better off in a traditional if you expect to be in a lower tax bracket when you retire.
By deducting your contributions now, you lower your current tax bill. When you retire and start withdrawing money, you’ll be in a lower tax bracket, thereby giving less money overall to the tax man.
If you expect to be in the same or higher tax bracket when you retire, you may instead want to consider contributing to a Roth IRA, which allows you to get your tax bill settled now rather than later.
But it can be difficult, if not impossible, to guess what tax bracket you will be in later in life, particularly if you’ve got a long way to go until you retire.
So if you’re not sure, another rule of thumb is to keep your retirement savings tax diversified, meaning you have accounts that will be both taxable and tax-free when you cash out in retirement.
For example, if you already have a tax-deferred 401(k) plan through your employer, you might want to invest in a Roth IRA if you are eligible.
The Roth also offers more flexibility: You can withdraw your contributions (but not the earnings) without incurring a penalty so you have more access to your money. When you take money out of a traditional IRA before retirement, the IRS socks you with a hefty 10% early-withdrawal penalty and taxes the money you take out as income at your current tax rate. So if you’ve got a long way to go before retirement, and you’re concerned about locking away your money for too long and want to be able to get at it if you need it, a Roth might be the way to go.
You can rollover either a Roth or a Traditional IRA to a Gold SDIRA (self-directed individual retirement account) consisting of physical gold and other precious metals coins and bullion. If that is what you wish to do, we recommend viewing our page on Best Gold IRA Options.
Do you have any further questions on whether you should choose a Traditional or Roth IRA? Ask below!
Hello Uriah,
Very interesting article about the Roth vs Traditional, which should I choose?
For years my income has been increasing, I believe that a Traditional IRA will be the best option for me.
I also expect a lower tax category when I retire.
Therefore if I deduct my contributions today I can reduce my tax bill.
I will be grateful if you indicate if my choice is correct.
Thank you! Claudio
Hi Claudio,
Your choice is indeed correct. The traditional IRA is one of the best options in the retirement-savings toolbox. You can open a traditional IRA at a bank or a brokerage, and the universe of investments is wide open to you. But with that freedom comes responsibility. Traditional IRAs have a lot of rules—break one and Uncle Sam will ding you. Follow those rules, however, and you can end up with a sizable nest egg down the road.
With a traditional IRA, you can turbocharge your nest egg by staving off taxes while you’re building your savings. While generally you must have earned income to be able to contribute to a traditional IRA, there is an exception for nonworking spouses. In this case, a working spouse can fund a “spousal IRA” for the nonworking spouse.
Many tax deadlines fall at the end of the year. But there is an exception for IRAs. You can contribute up to the annual limit by the income tax deadline and still have the contribution count for the previous year.What if you have a 401(k) at work? That’s no problem. You can max out the contributions to your workplace plan and max out an IRA, too. The catch: You may not be able to deduct all of your IRA contributions.
Just keep these few things in mind.
Hello Sir
Thanks for this write up on IRA’s. I found this article very detailed and helpful to understand how this works. Delayed gratification is the name of the game here. Leave your money to grow so that you can enjoy your retirement. Also it is interesting to see the tax benefits of the Roth IRA is a game changes. I do not live in the US but my brother who is a Doctor does have an IRA. I am going to forward this article to him to review his IRA and make changes in his savings plans. Thank you for this information. Cheers
Hey Jake,
It feels great to know that you liked the article. Please do ask your brother to review his IRA option.
You can’t take a tax deduction for Roth contributions, but the money accumulates tax-free, and withdrawals are tax-free, too. If you contributed the maximum to a Roth for each of the past 20 years, you’d have nearly $200,000 in tax-free savings, assuming you invested it all in a fund that tracks Standard & Poor’s 500-stock index and reinvested the dividends.
Ed Slott, a CPA in Rockville Centre, N.Y., recognized that Roths would become a game changer and started a newsletter in 1998 to teach advisers about the accounts. Slott calls Roth IRAs “tax insurance” because once you’re invested in one, you won’t have to pay taxes on contributions or earnings again.
The new tax law makes Roth contributions even more attractive, now that tax rates are the lowest they’ve been in years but could rise in the future.
Hi! I need to admit that this topic sounds a bit complicated for me but you described it well and it`s easy to follow. Roth Ira sounds great and it is a good option to earn some money for retirement. I like that you can withdraw contributions at any time, it requires minimum distributions and it offers more flexibility. Is the Roth Ira pretty new on the market? keep up the good work!
Hi Luke,
Thanks for the appreciation. The sooner that you start saving for retirement and the more time you have to save for retirement the greater the likelihood that you will have a larger nest egg. Young professionals—aka Millennials in their 20s and 30s—who decide to start saving for retirement can do so in a variety of ways and accounts.
A Roth IRA may be the answer for Millennials. A young professional can go online and open up a Roth IRA in a matter of minutes. Whenever they choose, they can contribute money to it: up to $5,500 per year or up to their taxable income for that year, whichever is smaller. Money in a Roth IRA grows tax-free and can be withdrawn tax-free.
Unlike most other retirement accounts, with a Roth IRA a Millennial can make tax-free withdrawals at anytime. This is huge, because withdrawing money from most other retirement accounts before age 59½ will incur a 10% tax penalty, along with income tax to pay on the withdrawal amount.
Contributions (or the amount equal to them) can be taken out at any time. If the money that was contributed to the Roth IRA has any earnings like interest, dividends or capital gains, the equivalent of this amount can be withdrawn penalty- and tax-free after five years if you are either age 59½ or meet certain special criteria.
These criteria include life events such as becoming a first-time homebuyer. When Millennials go to purchase their first primary residence they can withdraw up to $10,000 of earnings tax-free.
One point on the other side: A Traditional IRA will provide an instant tax deduction that you don’t get with a Roth because your taxable income is reduced by the amount of your contribution.
However (back to tax advantages): The big Roth payoff is when you retire because both your contribution and all the money it has earned over the years can be withdrawn completely tax free. With a Traditional IRA, you get the deduction going in and no taxes until you retire, but then both the original contribution and all its earnings will be taxed at your current income tax each year. And, from age 70½ on, you will be forced to make annual required minimum distributions (RMDs) that will raise your taxable income whether you need the money or not.
Uriah you articulate the difference between a traditional IRA and ROTH IRA very well. After reading your article, I realize I had some misconceptions about ROTH plans (I’ve only had experience with a traditional IRA). You’ve given me some food for thought and options to look into. Thank you for your insights!
Hey Cheri,
Great to know I could clarify your doubts through this write-up. If you think traditional and Roth individual retirement accounts are the same, think again. There are some big differences between these popular retirement savings plans.
With traditional IRAs, you get a tax deduction upfront. The taxes you pay on that money are delayed until you withdraw it in retirement. Roth IRAs, on the other hand, are funded with post-tax money.
“With a traditional IRA, you’re at the mercy or uncertainty of what future higher tax rates might do to your retirement savings,” Slott said. “With a Roth IRA, you don’t have to worry about future rates, because your tax rate in retirement will be zero.”
Great post on the IRA battle,
You put this very common sense like, makes it very easy to understand. From reading this post it seems pretty easy to decide on which direction to go. I myself plan on continuing to progress in the income, so I would want to stick with traditional correct?
I see benefits from both ends, who knows what the tax situation will be like in 30 years!
Cheers,
Nic
Hello Nic,
If you are eligible to contribute to both types of IRAs, you may divide your contributions between your Roth and traditional IRA. However, your total contribution to both IRAs must not exceed the limit for that tax year (including the catch-up contribution if you’re 50 or over). If you decide to split your contributions between both types of IRAs, you may choose to contribute the deductible amount to your traditional IRA.
Before splitting your IRAs, however, consider additional fees, such as maintenance fees charged by your IRA custodian/trustee for maintaining two separate IRAs. “It typically makes more sense to consolidate your retirement accounts of the same type (pre-tax vs. after tax or Roth). This saves on fees and makes your life easier from a tracking perspective,” says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, Mass.
Note also that placing bulk trades into one IRA instead of placing separate trades in separate IRAs could help you save on trade-related fees. Finally, consider the short-term benefits as well as the long-term benefits and decide which outweighs the other.
You may contribute to a traditional IRA and elect not to claim the tax deduction even though you are eligible to do so. The benefit of not taking a deduction is that the distribution of the equivalent amount is tax and penalty free – like the distributions of the Roth IRA. The earnings distributed from the traditional IRA, however, will be treated as taxable income, whereas qualified distributions of earnings from a Roth IRA are tax-free.
Finally, you may split your contribution between both types of IRAs and enjoy the benefits of both.
Hey there. I appreciate the informative and thorough article. It really helped me a lot. I am ready to invest in Gold because many of my friends recommened this to me – and some of them are real economic experts. I am still learning about possiblites and informing myself about different ways of investment.
That is how I bumped into your website. I still have no real retirment plan but I am willing to try investing in gold. I am 25 years of age. I am guessing that taxes will go up when I become ready for retirement – so I think Roth IRA is a better choice for me.
I wanted to know, which plan will make more money at the end, when you are eligible for withdrawal? Traditional or Roth?
Thank you.
Strahinja.
Hi Strahinja,
It is great to know that you liked the article and are willing to invest.
If you are looking to boost your retirement savings, it’s a wise idea to open an individual retirement account, commonly known as an IRA. Though similar to 401(k) plans found in the workplace, an IRA can give workers more investment options and greater control over how their assets are managed.
In 2019, you will be able to contribute up to $6,000 to an IRA or, if you’re age 50 or older, up to $7,000. You can also choose between two IRA options: a traditional account or a Roth account.
Which one is better? “The answer is really going to depend on your individual circumstances,” says Ryan Reed, a wealth strategist with financial firm PNC Wealth Management. A traditional IRA offers an immediate tax deduction for contribution, while a Roth IRA can provide tax-free income in retirement.
Here’s what Reed and other experts say you need to know in order to make an informed decision.You must consider the tax benefits. If you expect that your tax rate will decrease when you retire, opt for a traditional IRA. Traditional IRAs mean tax savings now. Contributions made to traditional accounts are tax deductible. In exchange for receiving a deduction now, the government taxes withdrawals made in retirement at a person’s regular tax rate. If a withdrawal is made before age 59 ½, the IRS also adds a 10 percent penalty. Regardless of whether a retiree wants the money, the government insists people begin taking a required minimum distribution, known as an RMD, at age 70 ½.
“Someone is going to pay taxes on it sooner or later,” says Yvonne Marsh, a certified financial planner and CPA with financial firm Marsh Wealth Management in Knoxville, Tennessee. High-income earners may find it best to take a deduction now and pay taxes in retirement when they could be in a lower tax bracket. If a retiree passes away prior to using all the money in a traditional IRA, heirs will pay taxes on the proceeds instead.
How to Invest a Self-Directed IRA
If you anticipate higher taxes in retirement, a Roth IRA can be advantageous. In 1997, a new version of the IRA was created. “Senator William Roth of Delaware came up with this idea to help people save more,” explains Eric Aanes, CEO and founder of financial firm Titus Wealth Management in Larkspur, California.
Rather than receive a tax deduction for contributions, Senator Roth proposed allowing people to fund an IRA with after-tax money. Since the contributions had already been taxed, withdrawals in retirement would be tax-free. What’s more, gains made on the investments could also be withdrawn tax-free. His idea was included in the Taxpayer Relief Act of 1997, and this new savings option became known as the Roth IRA.
Unlike traditional IRAs, there is no RMD for a Roth IRA. While there is still an early withdrawal fee of 10 percent for any gains pulled out of an account prior to age 59 ½, workers can take out their principal payments at any time without penalty.
Take your current tax bracket into account. Your tax bracket is one of the most important considerations when deciding between a traditional and Roth IRA. “You might be in a higher tax bracket (now) than you’ll be in retirement,” Reed says. In that case, it might be best to contribute to a traditional IRA and receive a deduction while your tax rates are higher.
However, don’t assume your tax bracket will be lower after you stop working. “What I find with clients is that’s not always the case,” Reed says. Pensions, Social Security and investments can quickly add up to replace much of a person’s pre-retirement income.
Retirees also often forgot or underestimate the amount of the required minimum distribution that must be taken out of traditional 401(k)s and IRAs after they reach age 70 ½. That amount is dictated by a formula that could push a person into a higher tax bracket or make a portion of his or her Social Security benefits taxable. Understand when you’ll need the money. Both traditional and Roth IRAs can be subject to early withdrawal penalties, but Roth accounts offer more flexibility. All money withdrawn from a traditional IRA before age 59 ½ is subject to a 10 percent penalty in addition to regular income taxes, though the penalty can be waived in certain situations, such as if you’re unemployed and use the money for health insurance.
However, only the gains made on contributions to a Roth account are subject to the penalty. You can take out the principal amount at any time and for any reason. Since that money has already been taxed, it isn’t subject to additional income tax either. A Roth IRA is also more flexible in retirement. Remember, you’ll have to take a distribution from a traditional IRA every year after you hit age 70 ½. That extra income will be taxable and could push you into a higher bracket.
For a great benefit, our #1 recommendation for rolling over your IRA to a Gold IRA is Regal Assets:
http://bestiraoptions.com/best-gold-ira-options/top-10-gold-ira-companies/regal-assets
Great post and good info.
As an investor, I’ve heard about IRA before, but I never tried it.
I’m more in other things than this, however, your post is interesting and it got me curious.
Not for me yet, but for my dad, he is retired, and he can invest in those things, but I think the traditional one will suite him better.
Thanks a lot for sharing it.
Hi Emmanuel,
Thanks for the appreciation. As far as investment for your dad is considered, definitely a traditional IRA is going to benefit him. Check out this link to get great returns on your investment.
http://bestiraoptions.com/best-gold-ira-options/top-10-gold-ira-companies/regal-assets
Saving for retirement is important, and someone making the most of the savings they’re able to set aside will make a huge difference in how comfortable their retirement is. The federal government offers many tax-favored retirement savings vehicles, and one of the most popular is the IRA.
One question millions of people face every year is whether to use a traditional or Roth IRA. Each one has its advantages and disadvantages, but there are several reasons why the traditional IRA can be better than a Roth IRA. Here are three advantages of traditional IRAs over Roth IRAs that may apply to individual’s financial situations.
1. Traditional IRAs offer a tax break right now
The No. 1 reason why many people put money into IRAs is because they need a last-minute tax break. Contributing to a traditional IRA is one of the only ways someone can reduce the amount of tax they owe after the end of the tax year, because they’re allowed to contribute toward their 2017 tax year limits through the tax filing deadline of April 17, 2018.
For most taxpayers, contributions to a traditional IRA are tax-deductible for the tax year to which they allocate them. With limits of $5,500 for those under 50 years old and $6,500 for those 50 or older, maxing out a traditional IRA can save someone hundreds or even thousands of dollars on their taxes right now, depending on their tax bracket. Often, the tax break can let someone save even more toward retirement, boosting the size of their nest egg and giving them a positive incentive to keep contributing. Roth IRA contributions aren’t tax deductible, and so they don’t offer that upfront nudge to tell someone they’re doing the right thing.
2. Someone can always contribute to their traditional IRA
The only requirement to contribute to a traditional IRA is having earned income from a job or other work. With Roth IRAs, on the other hand, there are income limits above which you’re not allowed to contribute anything at all toward your retirement. For instance, someone who is single and has income above $135,000 in 2018, won’t be allowed to make a Roth contribution this year.
There are income limits that apply to traditional IRAs, but they only determine whether a contribution will be tax-deductible or not if someone or their spouse is covered by an employer retirement plan. A person can always make a contribution, and that clears up some uncertainty that can make it more challenging when working with a Roth IRA.
3. Wait to pay Lower taxes in retirement
For workers in their prime earning years, the biggest advantage of the traditional IRA is that it gives them the ability to avoid paying tax when they’re in a high tax bracket and instead wait to pay tax until they’re in a lower tax bracket in retirement. Once they hit age 59 1/2, they can start taking IRA distributions without penalty, and that gives them the power to decide when they’ll pay taxes on their retirement money. Spreading out taxable income throughout their retirement will often result in paying less in overall tax, leaving them with more after-tax money to spend after they’ve retired.
The flip side of the argument
Don’t take these reasons as arguments that Roth IRAs are useless. Roths have a lot going for them, and as Fool personal finance guru Maurie Backman notes in this article, someone can get tax-free income in retirement and greater access to their money over the course of their career in a Roth than traditional IRAs typically offer. Yet I’d still say that with retirement savings, someone shouldn’t want access to that cash until it’s time to retire, and since I plan to tap my IRAs to spend during retirement, rules about required minimum distributions aren’t a major concern for me or for many aspiring retirees.
IRAs are a great way to save for retirement, and traditional IRAs in particular have some great advantages over alternatives. Individuals shouldn’t wait another day to make the most of their retirement savings opportunities with an IRA.
Rest is sweet after labour only when it is adequately plnned for.
Going for the Roth IRA would have been a better option but for the restrictions and limitations placed on how much you can have. What if one is an entrepreneur with vast resources and income then one will go for the traditional IF A not mindingthe taxes.
I think I will prefer the storing as gold option. Will the gold later be sold and be converted to cash at retirement? Is it tax deductible?
Hi Kabirat,
I will be answering both your questions one by one. Let’s come to the first question.
Gold has always had a unique allure, and for the past century it has swung in and out of fashion with investors. The claims tap into our fear that with unrest in the Middle East and elsewhere, a plague threatening Africa and a disappointing job market at home, the end of life as we know it may be near. It’s tempting to call that 800 number and stock up on gold, whether Krugerrands and other coins, or gold bars. Indeed, several financial advisers interviewed for this article suggest you invest 5 to 15 percent of your portfolio in gold, just in case.
Despite these emotional appeals, many financial experts warn that gold (and, for that matter, silver, an even more volatile commodity) is just too risky, especially for retirees who need income-producing investments rather than an asset that can swing wildly in value within short periods, or languish for years.
“Gold itself doesn’t produce anything,” says Eric Meermann, a portfolio manager with Palisades Hudson Financial Group in Scarsdale, New York, which has $1.3 billion under management. “It just sits there — a form of money for people who don’t trust other forms of money, like cash or investment securities.”
Currency of fear
Gold has always had a unique allure, and for the past century it has swung in and out of fashion with investors, surging in times of economic stress or political turmoil. It’s not called the currency of fear for nothing.
In the wake of the 1970s oil crisis and years of high inflation, the price of gold hit a then-record peak of $850 an ounce in 1980. Next, after the Federal Reserve raised interest rates to quell inflation, gold swooned and barely budged for two decades. It took 28 years, until 2008, for the price of gold to creep over $850 an ounce again.
Billionaire Warren Buffett, one of the world’s most successful investors, has a more colorful argument against gold. In a letter to shareholders in 2011, the Oracle of Omaha said all the gold mined would amount to a 68-foot cube, the money equivalent of all the cropland in the U.S., 16 ExxonMobils and a trillion dollars in cash. “A century from now, the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops—and will continue to produce that valuable bounty, whatever the currency may be. ExxonMobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons),” he wrote. “The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond.”
Gold: Pros and Cons
Pros
• Hedge against inflation
• Diversification
• Tends to grow in value during bad economic times
Cons
• Not an income producer
• Volatile
• Speculative; only worth what buyers will pay
And don’t overlook taxes. Gold is considered a collectible, and profits from a sale are taxed at a maximum rate of 28 percent. In comparison, long-term capital gains on stocks and bonds are taxed at a top rate of 15 percent for most investors.
Insurance policy
If you’re still convinced gold is for you, you can invest in funds that own gold, though many gold fans — often called goldbugs — prefer buying the physical metal, even though it may mean additional costs for storage and insurance.
Steve Brown, 60, of Texas, bought his first gold coins in 2011, and they now are about 10 percent of his holdings. He sees the metal as a way to diversify his investments and protect against inflation, which he suspects is much higher than reported.
Gold, he says, is an insurance policy, not unlike buying a homeowner’s policy for a house that may never burn down: “If everything goes crazy, it gives me some peace of mind.”
But, in the end, many advisers say to take all that talk of doomsday with a grain of salt. Ritholtz, for one, asserts that the imminent demise of the dollar, the world’s dominant currency, is highly unlikely. “Trust me, the people who run Goldman Sachs are not going to let their dollars become worthless,” he says wryly. “And anyone who thinks that the dollar is worthless can send their money to me for proper disposal.”
Let’s come to the second question now.
Many investors add gold to their portfolios to increase diversification and hedge against inflation. The rules governing IRAs acknowledge this interest in precious metals and carve out exceptions to a general prohibition against holding collectibles in the account. Buying and selling gold in an IRA has several tax implications, and most of them are helpful.
Tax on Collectibles
Gold sales made through a regular, non-IRA account, are taxed as collectibles, which are defined as tangible personal property that carries additional value due to rarity and/or market demand. Examples include gems, baseball cards, coins, rare books, antiques, art and rare stamps. Profits from the sale of collectibles held for a year or longer are taxed as long-term capital gains, but at a special rate. Instead of the normal long-term capital gains rates of 0, 15 and 20 percent, the long-term collectibles tax rate is 28 percent. Short-term profits from the sale of collectibles are taxed as ordinary income.
The profit or loss on the sale of a collectible equals the sale proceeds minus the cost basis, which includes the purchase price, broker fees, auction fees, insurance costs and storage costs. When you buy gold in the form of coins and bars from a gold dealer, you are charged the retail price, but if you sell it back, you receive the wholesale value. You therefore must absorb the buy/sell price spread before you can realize a profit on the sale of your gold.
Tax Treatment of Gold Losses
If you sell for a loss gold not held in an IRA or other tax-sheltered account, you can offset the loss against any capital gains you have for the year. Long-term capital losses must first offset long-term capital gains, and short-term losses must first offset short-term gains before the losses are applied to any remaining capital gains. Any excess losses can be used to offset up to $3,000 of ordinary income. If an excess loss still remains, it can be carried forward to offset future capital gains and ordinary income.
Gold IRA Investments
Certain types of physical gold can be held in a precious metals IRA, which is an IRA administered by a trustee prepared to buy and sell gold and other precious metals on the IRA’s behalf. Typically a precious metals dealer or broker serves as the IRA trustee, and the IRA must be set up as a self-directed account. This kind of account gives you the most freedom to choose investments, and you get to pick the IRS-approved account administrator. Certain rules apply to the metals you can hold in any type of precious metals IRA, such as a gold and silver IRA, including:
• The permitted precious metals are gold, silver, platinum and palladium.
• The precious metals must be in the form of bullion coins and/or bulk forms (rounds and bars). Numismatic coins do not qualify.
• The metal must meet certain specifications for quality and size. For example, one-ounce, half-ounce, quarter-ounce and tenth-ounce U.S. gold coins can be held. Foreign gold coins can qualify if they are at least 99.5 percent pure gold. For example, the Canadian Gold Maple Leaf coin is acceptable, but the South African Krugerrand is not.
• Gold bars and rounds must meet the contract standards set forth by an approved commodity exchange, and must be produced by an exchange-approved refiner or a national government mint.
• The precious metals must be in the physical possession of the IRA trustee.
• You cannot contribute precious metals to your IRA, as only cash contributions are allowed. You may be able to roll over precious metals already held in another IRA or qualified retirement account.
Traditional IRA Tax Treatment
Aside from the specialized trustee, a gold IRA is like any other. A traditional IRA can provide a tax deduction on contributions, and distributions are taxed as ordinary income at your marginal tax rate. If you withdraw money from a traditional IRA before age 59 1/2, you might have to pay a 10 percent early withdrawal penalty unless you qualify for an exception. You must begin taking required minimum distributions after reaching age 70 1/2, based upon your life expectancy as determined by the IRS. These rules have certain implications for traditional gold IRAs:
The details of the profit or loss on your gold investments do not affect the tax you’ll pay when you distribute money from your IRA. While you may want to keep detailed records on the profitability of each of your transactions, including the costs to store and insure the gold, those details are not reported to the IRS and don’t affect your tax bill. You are not affected by the collectibles tax rate. The 28 percent rate on the long-term capital gains for collectibles might be higher or lower than your ordinary tax rate when you withdraw money from your IRA, which means you might end up paying a higher or lower rate than the 28 percent. High-bracket IRA owners are disadvantaged by this feature, but low-bracket owners will benefit from their relatively lower tax on withdrawals.
I hope this clears everything.
I wish I could have read this article 33 years ago, I would be financially better off than I am. Your website is laid out beautiful with great pictures and I am sure will be very helpful to people viewing it. Hopefully IRA will be around long enough for out teenagers to get the benefits. So keep up the good work. Ray
Hi Ray,
Thanks for applauding my work.
IRA stands for Individual Retirement Account, and it’s basically a savings account with big tax breaks, making it an ideal way to sock away cash for your retirement. A lot of people mistakenly think an IRA itself is an investment – but it’s just the basket in which you keep stocks, bonds, mutual funds and other assets.
Unlike 401(k)s, which are accounts provided by your company, the most common types of IRAs are accounts that you open on your own. Others can be opened by self-employed individuals and small business owners. There are several different types of IRAs, including traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs.
Unfortunately, not everyone gets to take advantage of them. Each has eligibility restrictions based on your income or employment status. And all have caps on how much you can contribute each year and penalties in most cases for yanking out money before the designated retirement age.
Because money in the plan grows free from the clutches of Uncle Sam. That is, the income from interest, dividends and capital gains can compound each year without taxes nipping away at it.
In addition, you also can escape taxes on either the money you put into the plan initially or on the money you withdraw in retirement, depending upon whether you choose a traditional or Roth IRA.
So what’s the catch? The government limits the amount of money you can put into an IRA each year. Most people under 50 can contribute no more than $5,500 a year; that limit rises if you’re older. The IRS dictates a few ways in which you can’t use the money in your IRA, including lending money to yourself, using it as collateral for a loan and buying real estate for your personal use. Beyond those exceptions, you can invest in just about anything: mutual funds, individual stocks and bonds, annuities and even certain real estate.
It’s a good idea to diversify your assets among stocks, bonds and cash. Stocks can provide long-term growth potential, while bonds and cash offer some protection against market setbacks. The allocation that’s right for you comes down to how long you’ll have your money invested and what sort of short-term ups and downs you’re willing to accept in the value of your portfolio. The longer your investment horizon, the more it makes sense to invest in stocks. But if you can’t stomach occasional market downturns, you might want to hold a larger share of bonds.
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http://bestiraoptions.com/best-gold-ira-options
I have been remiss in saving for my future. I’ve learned a lot about IRA’s and other investments this year from and, because of one of my retired friends.
Although, financially, things have been looking up after shifting focus on helping myself instead of helping others before myself. I think I am in the same boat in different waters than your reader, Strahinja. I am 20 years older but, not a lost hope yet. Gold will be my first go to if it does’t sky rocket this year.
I would love to have an IRA but, in my position I may have better luck with ‘bank on yourself’ type of account until I get a bit more heft in my purse. Do you think that would be a good way to build myself up?
The only thing i’m still not grasping…what is the minimum to put towards an IRA…is there a minimum a year as well as a maximum?
Hey Fyre,
A regular old savings account is a fine parking spot for money you need on hand the next five years or so. But it’s a poor place for money earmarked for expenses further down the road. Yet a recent Nerd Wallet survey found that 39% of Americans are forgoing investment growth on their savings for long-term financial goals because they prefer to keep that money — intended to provide retirement income — in cash.
Cash is safe. It’s certainly easier to access in a pinch than money in stocks or mutual funds. But there are much more effective ways to save for retirement, including some account options if you don’t qualify for run-of-the-mill places like a 401(k) or IRA.
Retirement accounts vs. savings accounts
IRAs, 401(k)s and 403(b)s are specifically designed for long-term investment goals (retirement!) and have special features that cash savings accounts lack:
• Preferential treatment by the IRS – Depending on the type of retirement account you choose, you’ll get either an upfront tax break through deductible contributions (normal 401(k)s and traditional IRAs) or a back-end break via tax-free withdrawals in retirement (Roth 401(k)s and Roth IRAs). Plus, the IRS doesn’t tax investments as they grow within these accounts.
• Access to a broad array of investments – This might include individual stocks, mutual funds and even alternative investments like real estate investment trust funds or REITs.
• An easy way to separate long-term savings from near-term spending money – This way, you’re not tempted to dip into your reserves, which will short-change your future lifestyle.
Savers who fear tying up their cash should know: If you absolutely need to get to the money early, there are scenarios where tax- and penalty-free early withdrawals from retirement accounts are allowed. Roth IRAs even allow withdrawals of contributions at any time, though for the sake of your retirement, we caution against using that feature outside of emergencies.
Coming to the minimum amount required to put in an IRA. When most people think of investing, they think of the big Wall Street firms where their investors have millions upon millions of dollars. While some of these big Wall Street firms may have their own minimums, typically to open an IRA, there isn’t one.
For example, you could go to a bank, a local Edward Jones office, or even online, and there are plenty of places where you can start an IRA with no minimum.
Ally Invest, a popular online brokerage based out of St. Louis, Missouri, states on their website that there’s a $500 minimum to open an account. The reality is that that’s not the case. That’s just a suggested amount, so that way when you make your first deposit, you actually have enough money to make your first trade.
Why No Minimums?
An individual is only allowed to put up to $5,500 into an IRA if you’re under the age of 50 (as of 2013), $6,500 if you’re over the age of 50, into an IRA each year. There is no Roth IRA minimum requirement for how much you must put in. You can put in as little as you want to. That’s just the absolute most that you can. If you only wanted to put $50 into an IRA, you could do so.
Where I think most of the confusion comes into play is making the actual investments inside the IRA. Putting money into an IRA isn’t investing, it’s only the first step. The IRA is only a vehicle for investing the money.
For example, if you only put in $100 into your IRA and you want to buy a share of Google stock, it’s not going to happen. With Google’s stock price currently being above $600 per share, you’re one-sixth away from being able to own that one share. But with that $100 you can buy stock in businesses that have stocks for much less. Whether you’re looking to buy an individual stock, an ETF, or an individual bond, you must have at least that much in your IRA before you can buy that investment.
Here is our page that is the best guide to investing in gold for your IRA:
http://bestiraoptions.com/best-gold-ira-options
Do have a look.