How Much in Taxes Can a Roth IRA Save You Over a Traditional IRA?

IRAs have become the foundation for most U.S. taxpayers to build up their retirement nest eggs. In part this is because the Individual Retirement Account generally provides a great deal more investment options than the typical employer-sponsored 401(k) plan. This is even more the case when it comes to self-directed IRAs.

But the most attractive features of an IRA for most retirement savers are the ways that they can save on taxes. And in many regards the tax advantages of a Roth IRA, while not as immediate as those that are available for a traditional IRA, are even greater. Let’s examine some of the scenarios relating to these types of IRAs.

Tax Savings for Deductible Contributions. First let’s first review the primary tax advantage of a traditional IRA. At the top U.S. marginal tax rate for 2013 (39.6%), a taxpayer under the age of 50 who makes the maximum allowable IRA contribution of $5,500 can potentially take a tax deduction of nearly $2,200 during the tax year of that contribution. A taxpayer over 50 (whose maximum contribution is $6,500) can potentially take a tax deduction of almost $2,600 during the year of contribution.

Roth IRAs Provide for Tax Free Withdrawals. In contrast to traditional IRAs, Roth IRAs provide their tax benefits on the back-end, in the form of tax-free withdrawals from your account. Consider a taxpayer who makes $5,500 annual contributions to their Roth IRA for 25 years. At a 7% rate of return, their account balance at the end of those 25 years would be just over $370,000. If that same taxpayer finds themselves at a 25% tax rate during retirement, not having to pay taxes on withdrawals saves over $90,000 in taxes (which you’d have to pay if that same account were a traditional IRA). And as your Roth IRA account balance climbs higher, you’ll save even more in taxes.

No RMDs Means Longer to Grow Tax-Free. Roth IRAs are not subject to the rules on required minimum distributions, as traditional IRAs are. This means that once you reach age 70½ you can continue letting your IRA investments grow, rather than having to withdraw a portion each year. This can generate even more income, and help you avoid paying even more in taxes.

Continued Contributions into Retirement. Furthermore, you can’t contribute to a traditional IRA once you reach age 70½, whereas you can continue making Roth IRA contributions throughout your lifetime. This can be a great way to boost your tax savings if you’re able to finance your retirement using other savings or assets.

Estate Planning. Finally, the Roth IRA rules for passing down your account to your heirs are much more favorable than those for passing down a traditional IRA. These can help you save even more taxes while helping you reach your estate planning goals.

Feel free to contact Quest Trust Company if you have additional questions about how a self-directed Roth IRA can help you reach your long-term retirement goals.

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