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Comparing Roth and Traditional IRAs

After deciding you want to invest in an individual retirement account or IRA, how do you determine whether a Roth or Traditional IRA is best for you? A Roth IRA allows your funds to grow tax free. A Traditional IRA allows your funds to grow tax deferred, meaning you pay taxes at the time of withdrawal. Let’s dig into the characteristics of both, so you can make an informed decision about which is best for you and your financial goals.

In terms of eligibility requirements, Roth IRAs are open to anyone 18 or older who has earned income within specific IRS income limits. Traditional IRAs are open to anyone 18 or older with earned income. Income does impact whether contributions are tax-deductible for Traditional IRAs, though.

The primary difference between Roth and Traditional IRAs is how they are taxed. Roth IRAs grow tax-free and traditional IRAs grow tax-deferred until withdrawn. Roth IRA contributions are made with after-tax dollars and are not tax-deductible. Traditional IRA contributions are made with after-tax dollars as well, but they are tax-deductible if you meet specific income requirements. Oftentimes, Traditional IRAs are thought to be a good fit if you expect to be in a lower tax bracket when you retire. Roth IRAs can be best if you are in a lower tax bracket today and anticipate being in a higher tax bracket when you retire. It is important to note that if you open a Roth IRA, you can no longer convert it to a Traditional IRA later.

In addition to tax implication and contribution differences, there are also different rules around withdrawals. Roth IRAs do not have a required minimum distribution (RMD), which means you are not required to withdraw a minimum amount of money at a certain age. Traditional IRAs, in comparison, typically require you to withdraw a minimum amount of money starting at age 73. For Roth IRAs, you can withdraw contributions — but not investment earnings — at any time without additional taxes or penalties from the IRS. This can be especially helpful if you decide you would like to use the funds for a down payment on a home or for another large expense or life event. It’s important to note that if you withdraw earnings from a Roth IRA prior to age 59½, you may incur a 10% tax penalty. Any withdrawals made from a Traditional IRA prior to you turning 59½ will require you to pay taxes on those earnings and contributions as well as the 10% tax penalty.

Regardless of the individual retirement account you choose, once you open an IRA and select your investments, you will be saving money for your future with the advantage of compound interest. Compound interest is the interest on savings calculated on the initial principal investment and accumulated interest from previous periods. So, the compound interest you earn — whether in a Roth IRA or a Traditional IRA — allows your money to work for you. Pick the one that’s best for you and watch your money grow!

Sources:

https://www.investopedia.com/terms/r/rothira.asp

https://investor.vanguard.com/accounts-plans/iras/traditional-ira#:~:text=A%20traditional%20IRA%20is%20a,you%20make%20withdrawals%20in%20retirement

https://www.nerdwallet.com/article/investing/what-is-a-roth-ira

https://www.fidelity.com/retirement-ira/ira-comparison

https://www.cnbc.com/select/traditional-ira-vs-roth-ira/

https://www.irs.gov/retirement-plans/retirement-plans-faqs-regarding-iras#:~:text=You%20can%20roll%20over%20your,over%20to%20another%20Roth%20IRA

https://www.investopedia.com/terms/c/compoundinterest.asp