Traditional and Roth IRAs are the widely preferred investment plans as both these plans offer to allow the income to grow tax free by deferring the taxes. The amount deposited in the IRA accounts are levied with no taxes on the dividends or capital gains made through its contributions.
Merits of Traditional IRA:
Anyone who has an earned income is allowed to contribute with a maximum limit of his annual earned income. An individual is not compelled to any one type of investment and is free to choose from a range of options like stocks, annuities, mutual funds, bonds, etc. The investment grows tax-deferred until retirement at the age of 59.5 which gives an advantage of paying less taxes if the tax bracket is lower ate the time of withdrawal. The contributions can be made right until mid-April of the next financial year to make payments into IRA giving a longer period to add savings to the account.
De-merits of Traditional IRA:
Once the age of 70.5 years is crossed, one is compelled to take the Required Minimum Distributions (RMDs) failing which heavy penalties will be charged.
This plan may not be useful to save tax if already covered by another retirement plan at work based on the income slab and tax rates.
A high penalty of 10% will be levied in case an individual chooses early withdrawal before 59.5 years of age.
It restricts the investment towards certain insurance contracts, precious metals, antiques, etc.
Merits of Roth IRA:
It offers many early withdrawal plans like withdrawing up to $10,000 for first time home buyers, for paying study expenses of self or dependents, etc. The contributions into this IRA is made after amount after being taxed at salary/income source. There are no fixed withdrawal deadlines and hence the amount can indefinitely be allowed to grow indefinitely. In case of early withdrawals, the contribution amount can be withdrawn penalty free if the Roth account has been at least five years old and the individual is 59.5 years of age.
Demerits of Roth IRA:
The contributions to this plan are not tax-free as compared to traditional IRAs. As these form a part of gross income, it puts an individual in a higher tax bracket or makes him ineligible for several related tax benefits. The contributions toward these IRAs are limited to certain limits which restricts the amount that can be invested if the income grows beyond the eligible limits. The tax on contributions can become a burden if an individual on a higher tax bracket is trying to convert a portion of his Traditional IRA into a Roth IRA by requiring him to pay large amount towards a one-time tax deduction.
Each IRA has its own advantages and disadvantages. One must be wise to choose the IRA plan based on his financial situation and after consulting a financial expert to talk him through the various conditions considering the individual’s capabilities.