Traditional Vs ROTH IRA - Which Should YOU Choose?

Hey guys Daniel here from Next Level life and today I'm going to be tackling a big topicToday I'm going to be examining traditional IRAs and Roth IRAs and trying to determinewhich one is actually betterOr at least which one would be better for various situationsBecause as regular viewers of this channel will know my favorite answer of all time isit depends

Because in the personal finance Realm, a ton of your decisions will depend on your ownspecific situationAnd that includes the answer to the question of which type of IRA is right for youNow I've noticed online that there's a lot of bits and pieces of information out therebut nowhere that I could find where you get the whole list of differences in one placeSo I'm going to make this video that place

In this video, I'm going to be going really in-depth into the differences between theRoth IRA and the traditional IRABut before I get into the differences between the two I want to briefly touch on the waysthat they're both the sameLet's get startedBoth the traditional and Roth IRAs can be contributed to by minors and non-working spousesas long as they meet certain special income rules

The deadline for making contributions is April 15thAnd under most circumstances, as long as you have enough earned income, the amount thatyou can contribute each year is $5,500 if your under the age of 50 and $6,500 if you'reover the age of 50And earned income is basically wages, salaries, and tips in most casesHowever things like union strike benefits, or in some cases long-term disability Benefits,and self-employment income in some cases is also considered to be earned income by theIRS

However things like interest and dividends or social security or alimony or child supportare not considered to be earned incomeI also want to take a moment to talk about MAGI, because a lot of what I’m going totalk about later won’t make sense without itSo how do you find out what your MAGI is?Well that’s really a two-part question because in order to find your MAGI you first haveto find your adjusted gross incomeAnd your adjusted gross income to put it simply is basically your gross income or the amountof money you make in a year minus any deductions that you're able to take on your tax returnwhich can include IRA contributions, student loan interest, tuition and fees, HSA contributions,and many other things besides

And once you've got that number you have to add back in some of those deductions you tookout to get your adjusted gross income to get your MAGINow in many cases, in fact in most cases, your AGI and MAGI will actually be identicalHowever, I’ll put a few things up on the screen, and if you deducted any of those thingson your tax return you would need to add them back into your AGI to find your MAGISo with that out of the way what are the differences between these two IRAs?The first thing that everyone brings up when talking about the differences between thesetwo types of IRAs is the differences in tax treatment

In a traditional IRA you can deduct some or even all of your contribution on your taxreturn, whereas with a Roth IRA you can’tHowever one thing that people often fail to mention when talking about the tax treatmentof a traditional IRA is that while in most cases you can deduct contribution, there aresome exceptions to that deduction ruleFor example if you're married filing jointly on your tax return and your spouse is coveredby a retirement plan at work and, as a couple, your MAGI is more than a $186,000 in 2017but less than $196,000 you can only take a partial deduction on your tax returnAnd if your MAGI is over $196,000, you actually can't take any deductions

And this is the case even if you yourself are not covered by a plan at workNow if you're the one that's covered by a retirement plan at work instead of your spousethe rules are slightly differentIf you're single or filing as head of the household and you make between $62,000 and$72,000 a year you can claim a partial deduction but if you make more than $72,000 then youcan't actually deduction that yearIf you're married filing jointly or you're a qualifying widow or widower, then you canclaim a full deduction as long as you make $99,000 or less

If you make more than $99,000 but less than $119,000 then you can claim a partial deductionAnd of course, anything more than that will stop you from claiming any deductionAnd of course you can't deduct your contribution for a Roth IRA, that's really the heart ofthe difference between the twoRoth IRAs are taxed now but can be pulled out tax-free later, whereas a traditionalIRA is usually tax-deferred now but then it would be taxed later when you pull the moneyout

A couple of other differences between the two plans is the ages at which you can actuallycontribute to the IRAsFor a Roth IRA you can actually contribute at any age however for a traditional IRA youhave to be under the age of 70 and a half in order to contributeAnother difference between the two is how much you can actually contribute, and I don'tmean the contribution limits per year, under normal circumstances they're both the samein that respect like I said beforeNo, I'm referring to some other contribution limitations on Roth IRAs

You see in 2017 if you're filing as single or head of the household and your MAGI ismore than $118,000 but less than $133,000 then you can only contribute a reduced amountand I will give an example here in just a secondAnd of course if your MAGI is over 133k then you can't contribute anyth

ing to the RothIRAIf you're married filing jointly or a qualifying widow or widower making between $186,000 and196,000 a year you can contribute A reduced amount and anything above that you can't contributeanythingWith one exception known as the backdoor Roth IRA which is basically where you contributemoney to a traditional IRA but then convert it to a Roth IRA

Now in order to figure out how much you can contribute to a Roth IRA (assuming you’renot going to use the backdoor method) I’m going to use an exampleLet's say that Bob is a single 45 year old lawyer who’s doing pretty well for himselfwith a MAGI of $120,000 per yearAs a result he does fall in between the 118k and 133k limits for a reduced contributionto the Roth IRAHow does Bob figure out how much he can put in?First he has to start with his modified adjusted gross income and then because he is filingas a single he must subtract 118k (it would be 186k if you were married filing jointly)

This leaves him with $2,000He must then take that divided by $15,000 (or $10,000 if he were married filing jointly)Why?I don't know it's just how the laws workBut that leaves him with 0

1333 and so onHe must then take that and multiply it by his contribution limitWhich since he's 45 years old would be $5,500If he were over 50 years old it would be $6,500

But he's not so 133 times $5,500 leaves Bob with $73333And then the last step for Bob is to take his contribution limit of $5,500 and subtractthe $733

33This leaves him with his reduced contribution limit for the year at $4,76667The next difference is penalties

If you have a Roth IRA you will not pay penalties for withdrawals taken before the age of 59and a half as long as long as those withdrawals are not more than the total amount you'vecontributed yourself to the IRASo say if Bob from earlier had invested $5,500 a year into his IRA for the last 10 yearshe would have contributed a total of $55,000 and he could now take up to that $55,000 outwithout incurring any penaltiesHowever if he took any more than that you would be hit with the 10% Federal penaltytax on the withdrawal of earningsSo say he had a few huge medical bills and withdrew $60,000 from his Roth IRA

He wouldn’t get penalized on the first $55,000 that he took out because they were his owncontributions, however on the last $5,000 he would be hit with a 10% penalty or $500Whereas in a traditional IRA there's a 10% Federal penalty tax on withdrawals of boththe contributions that you withdraw and the earnings before the age of 59 and a halfBut of course it's finance so there's always an exceptionAnd in this case your withdrawals may not be subject to the penalty tax if it's dueto any of the following reasons you see on your screen

Yeah Finance laws are unnecessarily complicated sometimesThe next difference between the two types of IRAs is that the Roth IRA has no requiredminimum distributions, but you must take a certain amount of money out of your traditionalIRA starting on April 1st of the year following the year you reach age 70 and a halfSo for example if your 70th birthday is may 20th, then you will be 70 and a half yearsold in November of this year meaning you would need to take a required minimum distributionfrom your IRA the following April 1stAnd then for every year after that you need to take it by December 31st

The amount of the required distribution varies depending on your life expectancyThe last thing that I want to talk about is inherited IRAsNow there are three ways to inherit an IRA if you're the account owner's surviving spouseYou can either do what they call assuming the IRA as long as you're the only beneficiaryon the account

And basically how the IRS treats it if you choose this option is they assume that theIRA you received was yours all alongWhich means that you can add your own contributions to it and if it's a traditional IRA you won'thave to take any required minimum distributions until the year after you turn 70 and a halflike we discussed beforeThe second option is to inherit the IRAWhich could have been named better I mean come on, why is it that if you inherit anIRA, inheriting the IRA is a term used for one of your three options

They could have made that clearAnyway “inheriting” an IRA basically means that you're going to transfer the amount inthe IRA you received into a different IRA that is in your name

Now if you do this you will have to begin taking the required minimum distributionsin the year following the previous IRA owner's deathWhich can be good if the spouse needs money right away, but it also means that the IRAwon't grow quite as much because you're no longer able to just keep letting it appreciateThe third and final option is to disclaim the IRA which basically means you just refuseto accept it either in part or in fullBut you're going to really want to fully think through the ramifications before doing thatbecause typically if you disclaim an IRA you can't change your mind later

Now if you're not the account owner surviving spouse, you can still either inherit the IRAor disclaim it, however if you choose to inherit it you must start taking the required minimumdistributions right when you inherit it under these circumstancesBut that'll about do it for me I hope you enjoyed the video and if you did or if youlearned something be sure to like And subscribe I've got a lot more of these Finance comingout in the near future as well as some more book summaries and other fun stuffAlso if you have any more questions about IRAs be sure to leave them in the commentsand I will do my best to answer themBut with that being said, thanks for watching and have a great day