A question we hear often is “Should I invest into a Roth IRA or a Traditional IRA”? What’s the difference between the two? Is one better than the other? Hopefully this will provide a bit of clarity!
Both Roth IRAs and Traditional IRAs are types of individual retirement accounts that provide tax-advantaged savings.
The main difference between the two is when you pay taxes on the money you contribute and when you pay taxes on the money you withdraw:
Traditional IRA: You contribute pre-tax dollars, which reduces your taxable income for the year. The money grows tax-deferred- meaning you don’t pay taxes on any gains until you withdraw it. When you withdraw the money in retirement, it’s taxed as regular income.
Roth IRA: You contribute after-tax dollars, meaning you pay taxes on the money you contribute in the year you earn it (now). The money grows tax-free which means you don’t pay taxes on any gains. When you withdraw the money in retirement, it’s tax free.
Generally speaking, if you expect your tax rate to be lower in retirement than it is now, a Traditional IRA may be a better choice. If you expect your tax rate to be higher in retirement, a Roth IRA may be the better choice. There are other factors to consider, such as income limits and contribution limits, so it’s always a good idea to consult a financial planner to determine which type of IRA makes the most sense for you.
Required Minimum Distributions
With a traditional IRA and any 401(k) plan, you must start taking withdrawals by April 1st of the year you turn 70 1/2. Roth IRA’s are exempt from required minimum distributions.
Can I Withdraw Money Without Penalty?
You can only withdraw money from a traditional IRA penalty-free if you’re over age 59 1/2 and your account has been open five years or more. However, you can withdraw your Roth contributions (not your earnings) at any time penalty-free!
