When it comes to retirement planning, there are two main types of individual retirement accounts (IRAs) to consider: the traditional IRA and the Roth IRA. Both offer tax advantages to help you save for retirement, but which type of IRA is best for you? To decide, you need to understand the differences between the traditional and Roth IRA, their respective advantages, and the implications of each on your retirement goals.
The biggest difference between the traditional and Roth IRA is the tax advantages they offer. With the traditional IRA, contributions are made with pre-tax dollars, meaning you can deduct them from your income taxes in the year they are made. This can result in significant tax savings now, as well as lower your tax burden in the future.
With the Roth IRA, contributions are made with after-tax dollars, meaning you do not get a tax break in the year the contributions are made. However, the Roth IRA has a major advantage. All qualified withdrawals from the Roth IRA are tax-free, meaning you will not pay taxes on any of the money you withdraw from your account.
The traditional and Roth IRA both have annual contribution limits. The traditional IRA has a maximum annual contribution of $6,000 for 2019, with an additional $1,000 catch-up contribution allowed for those 50 and older. The Roth IRA has a lower annual contribution limit of $5,500, with the same $1,000 catch-up contribution allowed for those 50 and older.
The traditional IRA has a strict set of rules regarding withdrawals. You are not allowed to withdraw from the account until you reach age 59 ½, or you will be subject to a 10% early withdrawal penalty. Furthermore, withdrawals from the traditional IRA are taxed as ordinary income.
The Roth IRA, on the other hand, has more flexible rules for withdrawals. You can withdraw your contributions (but not the earnings) at any time, without penalty. After age 59 ½, you can withdraw your earnings from the Roth IRA tax-free and penalty-free.
The traditional IRA has no income restrictions, meaning anyone with earned income can contribute to the traditional IRA. The Roth IRA has income restrictions, and you must have earned income to contribute. In addition, the amount you can contribute is reduced if your income is above certain thresholds.
The traditional and Roth IRA both offer the same range of investment options. This includes stocks, bonds, mutual funds, and exchange-traded funds. The only difference is that the Roth IRA offers tax-free growth, while the traditional IRA offers tax-deferred growth.
When deciding between the traditional IRA and the Roth IRA, it is important to consider your individual financial situation. The traditional IRA offers immediate tax savings, but withdrawals are taxed as ordinary income. The Roth IRA offers tax-free withdrawals, but you must have earned income to contribute and there are income restrictions. Ultimately, the best type of IRA for you will depend on your retirement goals, your income, and your investment strategy.