When planning for retirement one of the first questions you may have is what is the difference between a traditional vs Roth IRA? Although they have many similarities, there are some key differences that one should consider before deciding which one to contribute into.
What is an IRA?
First, let’s cover what an IRA is. IRA is an abbreviation for “Individual Retirement Account.” It is an account sent up for the purpose of saving money for retirement. Because one should never rely totally on social security for their retirement income, IRA’s offer additional savings that you can use after you retire. Many employers will offer matches on IRA contributions. This means they will match the contribution you make to your IRA sometimes dollar for dollar. One should check to see if their employer offers this when they are looking to start an IRA.
Traditional IRAs are open for anyone under the 70.5 years of age to contribute into. In 2019, an individual can contribute up to $6,000 a year into their traditional IRA. For individuals that make less than $63,000 in annual gross income, their contributions into their IRA can be tax deductible, which can be a benefit on their tax returns. Traditional IRAs are also tax deferred. This means that you will not have to pay taxes until you start taking payments (these are often referred to as distributions) out of your IRA. At that time, you will pay a 10% federal tax on the money you take out of your IRA, in addition to any state tax that may be required. Because traditional IRAs are tax free you are required to begin taking distributions from your IRA at age 59.5. There is also a penalty if you wish to take any money out of your traditional IRA before the age of 59.5. Although there are special circumstances in which this penalty can be waived.
A Roth IRA is set up a bit differently. Unlike a traditional IRA, there are no age restrictions, anyone can contribute into a Roth IRA so long as they have earned income. Just like a traditional though, the yearly limit on contributions is $6,000 per year. Unlike the traditional IRA, the contributions into a Roth IRA are not tax deductible. If you are someone who generally relies on their tax returns each year, a Roth IRA may not be your best option. On the other hand, since you will be paying taxes on your contributions into a Roth IRA, your distributions will be tax free. This means you will not have to pay taxes when you take money out of your IRA during retirement. Also, there are no penalties on early withdrawals from your IRA, so long as you meet a five year waiting period. This can give you a little more freedom with your money.
No matter which way you slice it, you will pay taxes on your IRA. The main difference between a traditional vs. Roth IRA is when you are going to pay those taxes. Regardless which one you choose, it is important to save for retirement and start as early as possible.
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This article is for informational purposes only. Please be advised that this article is not intended as legal or tax advice. Accordingly, any tax information provided in this article is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer. The tax information was written to support the promotion or marketing of the transaction(s) or matter(s) addressed and you should seek advice based on your particular circumstances from an independent tax advisor.