There are some tradeoffs for the benefits
of
tax-deferred
earnings you get with a traditional
IRA.
When you withdraw from your account, any
earnings are considered regular income and are taxed at your regular
federal income tax rate. If you deducted the contributions you
made to your account, tax is due on the entire withdrawal.
The fine print
If you withdraw before you’re 59 1/2,
you may also face an additional 10% penalty on the amount you
take. And you’re required to start taking regular withdrawals
when you turn 70 1/2. If you take too little in any year, you
could incur a 50% penalty on the amount that you didn’t withdraw.
Surprisingly, there are fewer restrictions
on
Roth IRAs.
No federal income tax is due if you’re at least
59 1/2 when you withdraw from your account, provided the account
has been open at least five years. And there are no mandatory
withdrawals, and so no penalties for withdrawing too little.
That means you can manage your finances to
suit yourself, or use your account to build the estate you’ll
leave your heirs. There may be tax consequences with that approach,
though, so you should discuss your plans with your tax or legal
adviser.
The benefits of tax-free income are hard
to beat, and they only get better as your income tax rate rises.
For example, if you were single and withdrew $40,000 in one year,
you would have about $8,000 more in your pocket if the money came
out of a Roth account than out of a traditional IRA.
