Roth IRA vs Traditional IRA

The type of individual retirement account you choose can affect your long-term savings plan. So I figured it’s worth it to understand the difference between the two options. If your employer offers a 401K then check out this article before continuing on:

What are the major differences between a Roth IRA and a Traditional IRA?

1. Taxes
   1. Both have great tax benefits and breaks. But it is a matter of timing on when you get to realize these tax breaks. The Traditional IRA makes any contributions tax-deductible on both state and federal tax returns for the year you make the contribution. However, withdrawals in retirement are taxed at ordinary income tax rates.
   2. Roth IRA provide no tax benefits for contributions, but any earnings and withdrawals are tax free.
   3. In summary, Traditional IRA has tax benefits on the way in and Roth IRA has tax benefits on the way out!
2. Income limits
   1. Anyone with income and younger than 701/2 years old can contribute to a Traditional IRA. Whether or not Traditional IRA contributions are tax deductible depends on your income and if you (or your spouse) are covered by a retirement plan through your job.
   2. Roth IRAs do not have any age restrictions, but they do have income eligibility restrictions. For example, single tax filers must have less than a modified adjusted gross income of $135,000 in 2018 to contribute to a Roth IRA.
3. Withdrawal rules
   1. Traditional IRAs require minimum mandatory withdrawals of a certain percentage of the funds when the contributor reaches age 70 ½. This is whether you need the money or not.
   2. Roth IRA does not force any withdrawals during the contributor’s lifetime

How to decide which one to choose?

It really depends on your goals. There are a few main arguments in favor of each and I will try to highlight them below, but I would also be very curious as to what you guys think is best. We’re all trying to reach the finish line of financial freedom – no matter what vehicle (or vehicles) we take to get there, right?

Traditional IRA

Pro: This allows your money to grow for the majority of your life. You also can contribute pre-tax (tax deduction). So you can contribute more money in the early years allowing compounding interest to benefit you.

Con: If you become a high earner later in your life after setting up successful careers or passive income sources then your tax bracket might actually be higher when it is time to withdraw money than it was when you decided to contribute the money.

Roth IRA

Pro: allows your money to grow tax free after the original contribution. This makes it a great vehicle to build wealth and transfer wealth if you plan to leave your children (or their children) something behind.

Con: By limiting your contribution to post-tax dollars you do not get to grow as much money from the early years. There is also no short-term tax benefit.

Your Turn: Which do you prefer and why? Have you started contributing to your IRA account yet?

Related Posts