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Taxes. Do you enjoy paying them? Few Americans do, so millions of people in the United States hire tax professionals every year to help them legally minimize their tax liabilities. Of the many legal strategies tax advisers and investment advisers will recommend to help their clients minimize their tax liabilities, saving in an Individual Retirement Account is among the most common. However, Americans are often confused about which type of IRA they should choose for retirement and tax planning purposes: Roth? Traditional? What is the difference? We are glad you asked.

Immediate Gratification: The Traditional IRA

Traditional IRAs are often preferred by Americans. With an immediate tax deduction under many circumstances, the benefit of the tax savings today will often motivate people to choose a Traditional IRA over a Roth IRA. As an additional bonus, not only do investors in a Traditional IRA receive a tax deduction today, they also benefit from tax-deferred growth in their accounts. Considering these advantages, investing in a Traditional IRA appears to make sense: not only will you get a tax benefit now, but you will not pay taxes on the growth until the money is withdrawn. The problem with Traditional IRAs is that you may very well just defer your tax problem.

There are significant advantages to Traditional IRAs inasmuch as you may receive an immediate tax deduction and tax-deferred growth, but you also need to weigh some of the disadvantages. Once you reach age 70½, you must begin taking Required Minimum Distributions from your Traditional IRA. When the money is taken out of your account, you pay ordinary income tax on the money. If you have a high tax bracket in retirement, this can be quite painful. Additionally, contributions and earnings in a Traditional IRA are truly “locked” in the account until age 59½ unless you meet specific exceptions, or you are willing to take the hefty 10% penalty. As you weigh whether a Traditional IRA is right for you, it is critical to keep these disadvantages in mind.

Delayed Gratification: The Roth IRA

Roth IRAs have several key advantages over their traditional brethren. Firstly, Roth IRAs offer tax-free growth: assuming you meet holding period requirements, your withdrawals from a Roth IRA will not be subject to taxation. Additionally, you are not required to take Required Minimum Distributions from Roth IRAs. This is a tremendous boon to you if you are in a high tax bracket in retirement, or if you desire to leave income tax-free assets to your heirs. Roth IRAs also have less restrictive income limitations than Traditional IRAs for individuals who participate in company-sponsored retirement plans.

Even with these advantages, Roth IRAs are not right for everyone. For Roth IRAs, you contribute after-tax dollars. For this reason, many people in the highest tax brackets elect to contribute to a Traditional IRA as opposed to a Roth IRA. More senior Americans will also have fewer years to take advantage of the tax-free growth afforded by a Roth IRA, so it may make more sense from them to take an immediate income tax deduction.

Cutting Through the Complexity

With all of these contravening factors, it can be difficult to decide between a Traditional IRA and a Roth IRA. Believe it or not, the considerations explored here are the tip of the iceberg. At Semita Asset Management, we are here to help our clients sift through the complexities of financial planning and investment decision-making. If you have questions about Roth IRAs vs. Traditional IRAs, please reach out to us at service@semita-am.com. You can also select the “Schedule a Conversation” link on our website to get started. We are here to help you answer these important stewardship questions!

Keywords: Individual Retirement Account, Taxes, Roth IRA, IRA

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In preparing this information, we have attempted to present accurate information from our knowledge and sources. Nonetheless, we do not make any guarantees or warranties, expressed or implied, as to the accuracy of this information. Additionally, this information may not be entirely current and is subject to regular change. For the most current advice, we strongly urge you to consult with knowledgeable investment, tax and legal professionals who provide advice. We will not be held liable for any loss resulting from the implementation of the advice herein contained.