YOU ASK:

Roth IRA versus traditional IRA - which plan provides better tax deduction options?

WE ANSWER:

This will generally depend on whether you prefer to pay income taxes prior to or during retirement.

Under a traditional IRA, your contributions will accumulate on a tax-deferred basis until you retire or reach a certain age, when you have to start paying income tax.

If you select a Roth IRA, you will pay tax on your annual contributions prior to retirement but after reaching a certain age, you might receive distributions tax-free if you meet certain requirements.

Tax Deduction in Traditional IRA

Traditional IRA contributions accumulate on a tax-deferred basis, which means that the IRA holder does not pay any income tax until earnings are distributed. The advantage of deferring income taxation until retirement is that IRA holders are more likely to owe less money in taxes altogether because they won't have any other taxable income.

The federal government has imposed strict rules on the collection of deferred taxes so that it is guaranteed to receive the taxes in due course after the taxpayers retire. Here are the basic tax deduction regulations that apply to traditional IRA:

  • When the IRA holder reaches age 70.5, they must start receiving distributions from their traditional IRAs. This must begin the year in which the age is attained but no later than April, 1 of the following year.
  • The traditional IRA owned can choose to receive the distributions either in a lump sum, or in increments. There is, however, a required minimum distribution (RMD) that IRA owners must receive every year. If the minimum amount distribution option is selected, the RMDs must be distributed by the end of every year. Otherwise, a 50 percent excise tax may be imposed on the excess of accumulations.

Roth IRA Tax Deduction Rules

Roth IRA annual contributions do not accumulate on a tax-deferred basis; therefore Roth IRA holders can receive the distributions income-tax free as long as at least one of the following requirements is met:

  1. They have held the retirement plan for at least five years;
  2. They have reached age 59.5.

Further tax exemption restrictions might apply. There are no required minimum distributions applicable to Roth IRAs, and Roth IRA contributions can be made even after reaching retirement age.

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