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Understanding IRAs and Their Tax Advantages

An Individual Retirement Account (IRA) is considered one of the most valuable tax-advantaged accounts available for retirement savings. The two most popular IRAs are Traditional and Roth. Each offer unique tax benefits, including tax-sheltered growth and earnings. However, there are important differences between them that may impact your retirement savings potential. Thus, when it comes to IRAs, typically the question isn't should I open an IRA, but rather, which IRA is right for me?

Traditional IRA vs. Roth IRA

The most significant difference between the Traditional and Roth IRA is how the Federal Government taxes each account. With a Traditional IRA, contributions are tax-deferred until withdrawals begin. If you earn $65,000 a year and put $5,000 in a Traditional IRA, you can deduct the contribution from your income taxes. In this case, your taxable income would be $60,000, which could potentially lower your tax bracket. Your money will grow tax-free until you withdraw it. You can begin to make withdrawals at age 59 ½ without penalties, but you will then pay taxes on all capital gains, interest and dividends that were earned. With the Roth IRA, all contributions are already taxed, so when you've reached retirement age, you can withdraw all of the money completely tax-free. The long-term advantages of the Roth are compounding interest over many years. Choosing one over the other depends on a variety of factors, including your age, your income level, your current and projected tax bracket and how long you intend to work.

Let's Break It Down

The following chart shows key differences between the Roth and Traditional IRA. Because every situation is different, we strongly encourage you to consult your tax advisor before opening or transferring any IRA.

  Traditional Roth Roth IRA
Earnings Tax-deductible contributions (depending on income level); earnings are taxed upon withdrawal. Tax-free withdrawals of earnings are permitted (under certain guidelines).
Contributions Maximum of $5,000 annually; Contributions are tax-deferred, and can be made until the year you turn 70 ½. A maximum of $5,000 annually; No age limit to make contributions as long as you have reportable earned income. Contributions are not tax-deductible.
Distributions Withdrawals begin at age 59 ½, and mandatory distributions are required at age 70 ½. Heirs must report assets from a Traditional IRA as taxable income. No age limit requirement for required distributions as long as you earn taxable income. This allows you to leave more to your heirs who do not have to report Roth assets as taxable income.
Eligibility and Income Limits Available to anyone; no income restrictions. Available only to single-filers making up to $105,000, or married couples making a combined maximum of $166,000 annually, although some provisions may apply.
Investment Options A wide variety of investment options are available, including annuities, stocks, bonds and share certificates. A wide variety of investment options are available, including annuities, stocks, bonds and share certificates.
Penalties All funds withdrawn (including principal contributions) before 59 ½ are subject to a 10% penalty. Principal contributions can be withdrawn any time without penalty (under certain guidelines). Withdrawals of earnings before the age of 59 ½ are subject to a 10% penalty.
Catch-Up Provision For ages 50 and older, contribution limits are $6,000 annually. For ages 50 and older, contribution limits are $6,000 annually.

An IRA can be a great supplemental retirement account to your existing pension, 401(k) plan or Social Security. Once you determine which IRA is right for you, please consider a UNIFY IRA. In addition, UNIFY is happy to help you reach your savings goals, please phone our Call Center for more information. 

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