There are two different types of individual retirement accounts that are typically utilized: the traditional IRA, and the Roth IRA. Let’s look at the similarities between them, along with the differences.
Traditional Individual Retirement Accounts
When you have a traditional individual retirement account, you make contributions into the account with pretax earnings. This provides an immediate benefit, because your taxable income is being reduced as you simultaneously add to your savings.
This is the good news, but the bad news is that you are required to pay taxes when you start to make withdrawals from the account. You are allowed to take penalty-free withdrawals when you reach the age of 59.5, but under some limited circumstances, you could withdraw money earlier without being penalized.
With a traditional IRA, you cannot allow the money to accumulate throughout the entirety of your life without taking withdrawals. The Internal Revenue Service wants to get its money eventually, so you are required to take mandatory minimum distributions when you are 70.5 years of age.
Because of this requirement, generally speaking, these accounts have limited value from an estate planning perspective, but there are some exceptions.
Roth Individual Retirement Accounts
A Roth individual retirement account is funded with after-tax earnings, and this is a major difference. Because you already paid taxes, you are not taxed if and when you make withdrawals from the account. The age at which you can take penalty-free withdrawals is 59.5, but you are not required to take mandatory minimum withdrawals when you are 70.5 years of age.
This type of IRA can be used for estate planning purposes, and there is a strategy called the “stretch” IRA that is often implemented.
If you don’t need the money, you could allow the account to grow throughout your life without making any withdrawals.
When you create an individual retirement account, you name a beneficiary. The beneficiary would assume ownership of the account after your passing.
If the beneficiary is someone other than your spouse, he or she would be required to take mandatory minimum distributions after your death. However, the beneficiary could choose to “stretch” the IRA. When you stretch an individual retirement account, you take only the minimum distributions that are required by law.
This allows you to enjoy the tax-free growth for a maximum amount of time. Ultimately, the Roth IRA can prove to be a very effective estate planning tool.
Free Report on Individual Retirement Accounts
We have provided a basic overview in this post. If you would like to obtain more in-depth information about individual retirement accounts, download our special report.
The report is free, and you can access the download through this page: Free IRA Report.