When it comes to saving for your retirement, one of the most common ways to save is with an Individual Retirement Account (IRA). There are several types of these retirement accounts, but the two most popular are the Roth IRA and the Traditional IRA.
While both types of retirement accounts share some similarities, there are also some pretty significant differences. The primary difference between the two lies in how – and when – your IRA contributions are taxed.
Traditional IRA
With a Traditional IRA, the contributions you make are tax-deductible, providing you with an immediate tax benefit. For example, if you earn $50,000 and want to contribute $6,000 to a Traditional IRA, you can write off that contribution on your taxes for the year, reducing your gross (taxable) income to $44,000.
Our co-founder, Chadd Hoeft, calls this a “five-foot view” or “instant gratification” type of account.
The money you contribute to a Traditional IRA will continue to grow, tax-deferred, until you begin to make withdrawals at age 59 1/2 or later, at which point it will be taxed as income. Once you turn 72, you are required to take required minimum distributions (RMDs) by December 31st.
Roth IRA
The Roth IRA – which Chadd calls a “fifty-foot view” or “long-term gratification” type of account – differs from the Traditional IRA in that your contributions are not tax-deductible.
Using the above example, if you earn $50,000 and want to contribute $6,000 to a Roth IRA, you’re still paying taxes on the full $50,000. There is no immediate tax break.
The main benefit of a Roth IRA is that your money grows tax-free so that when the time comes for you to start making withdrawals at age 59 1/2 or later, all of that money comes out tax-free.
Another benefit is that, unlike a Traditional IRA, the Roth IRA does not require RMDs. So you can leave your savings in your account as long as you like.
Summary: Roth IRA vs Traditional IRA
In a nutshell, the differences between a Roth and Traditional IRA are:
Roth IRA:
- Contributions are not tax-deductible
- Money grows tax-free
- Withdrawals are tax-free
- No RMDs
Traditional IRA:
- Contributions are tax-deductible
- Money grows tax-deferred
- Withdrawals are taxed as income
- Annual RMDs required starting at age 72
Do you have questions about whether a Roth or Traditional IRA is right for you? Contact us and schedule a free, no-obligation consultation with one of our financial advisors.
