One of the most common questions that I hear regarding retirement planning is, “What is the difference between a Traditional IRA and a Roth IRA?” This question is generally followed by, “So, which is better?”
Before we can dig into this question, I want to point out that there is no objective “better” IRA. These are two different savings vehicles with different advantages.
So, one vehicle may be a better fit or option for a particular client, but that does not make it inherently better as a retirement account.
What is an IRA?
Before we break down what separates the two types of IRAs, we first need to understand what an IRA is and how it grows.
IRA stands for “individual retirement account,” and it is a savings vehicle that you can personally contribute to.
Since its inception in 1974, IRAs have been some of the most commonly used retirement savings vehicles. This is due, in large part, to the ease and convenience during the account setup.
Money contributed to an IRA is usually put into a wide range of asset classes. These funds can be put into stocks, bonds, CDs, mutual funds, target date funds, ETFs, ETNs, etc.
Traditional IRA
- Contributes pre-tax dollars
- Contributions are tax-deductible
- Money grows tax-deferred
- Taxed as ordinary income upon distribution
- Required minimum distribution at age 72
- Yearly contribution limit of $6,500 per individual ($7,500 for age 50 and older)
- No income limits – anyone can contribute to this vehicle, but deductions may be reduced for higher-income earners
- Generally, you cannot withdraw money before age 59 ½ – 10% penalty if you pull the funds early
Roth IRA
- Contributes after-tax dollars
- Contributions are not tax-deductible
- Money grows tax-free
- No tax implications upon distribution
- No required minimum distribution
- Yearly contribution limit of $6,500 per individual ($7,500 for age 50 and older)
- Income limits – individuals who make more than $138,000 are ineligible
- Generally, you cannot withdraw money before age 59 ½ – 10% penalty if you pull the funds early
As you can see, these vehicles have different advantages and disadvantages.
For example, you receive short-term tax help today with a Traditional IRA. However, the Roth IRA benefits you more with taxes in retirement.
A big advantage of the Roth IRA is that you are not required to withdraw money from it at a certain age. So, if you do not necessarily need to withdraw money at 75 years old, no one will make you.
Lastly, Roth IRAs have income eligibility limitations that Traditional IRAs do not have.
To reiterate, these savings vehicles benefit people in different ways. Depending on an individual’s situation, a Traditional or Roth IRA may fit better into their plan.
If you have any questions about which option may be best for you, please contact us!