What is the difference between roth ira and traditional ira

Q: Which type of IRA is best for me?

Retirement experts often recommend the Roth IRA, but its not always the better option, depending on your financial situation. The traditional IRA is a better choice when youre older or earning more, because you can avoid income taxes at higher rates on todays income.

IRA stands for individual retirement account, so it's literally an account that individuals can use to save for retirement. Most financial institutions offer IRAs as a product, alongside other financial accounts like a savings account or brokerage. When you open an IRA, you decide how to invest the money that's inside the account, the same way you would with a regular brokerage investment account. You can also buy insurance products such as deferred annuities that are designated as IRAs, which mostly affects how the money is taxed through the years.

Table of Contents Show

Traditional IRA
Individual Retirement Account summary
What is the downside of a Roth IRA?
Should I have a Roth and traditional IRA?
Which type of IRA is best for me?

Here's what's the same between traditional and Roth IRAs

There are two types of IRAs: traditional (often called 'pre-tax') and Roth. Financial institutions also often offer "rollover" IRAs, which is really just a traditional or Roth IRA that's funded with money that's rolled over from another retirement plan such as a 401(k) or 403(b).

Both have the same contribution limit. Each year you can add up to the IRS-designated limit to an IRA – for 2019 and 2020, the limit is $6,000 in total across all types, with an additional $1,000 catch-up amount if you're age 50 or older.

Both have the same contribution deadline. You can add money to your IRA account up until the April tax filing deadline and designate it a prior year contribution.

Here's what's different

	Traditional IRA	Roth IRA
How they are taxed	Contributions may be deductible Withdrawals are taxable	Contributions are not deductible Qualified withdrawals are tax-free
Age limit	You cannot contribute after age 70 ½, when you must begin withdrawals	No age limit
Income requirements	Anyone can contribute regardless of income, but you may not be able to deduct it if you have a workplace retirement plan available and make over the IRS limits for that year	Once your income exceeds the limits set by the IRS, you cannot make direct contributions
When you can withdraw	Age 59 ½ unless you meet certain exceptions	Contributions can be withdrawn at any time Growth can be withdrawn after reaching age 59 ½ as long as the account is at least 5 years old – there is an exception for first time home purchase that allows to withdraw up to $10k before age 59 ½
Required distributions	Must begin upon age 70 ½	No required distributions during your lifetime

How do you choose?

The biggest difference between the two types of IRAs is how the money is taxed. If you think you'll be in a lower tax bracket when you're making withdrawals from your IRA than you are when you're making contributions, then a traditional IRA would make more sense, assuming you can deduct your contributions.

On the flipside, if you think you'll be in the same or higher tax bracket in retirement, then a Roth IRA might make more sense so that you can have tax-free income in retirement and enjoy tax-free growth of your savings.

What if you have both?

It's common to have both types of IRA, which is totally fine. You can decide each year which one you want to contribute to, or you could split your contributions between both (remember the total amount can't exceed the annual limit).

Additionally, if you have traditional IRA money that you'd like to convert to a Roth IRA (for example, if you find yourself in a year with lower income than normal and want to go ahead and pay the taxes at a lower rate), you can do that at any time, up to the full value of your traditional IRA. Just remember that you cannot undo that decision, so if you convert your traditional IRA to Roth IRA and then the value of your account drops, you still have to pay tax on the value that the account was on the day your converted it.

So you're ready to start an IRA. But what kind of IRA do you need? This article outlines the two major IRA choices, their differences and what benefits they offer.

An individual retirement account (IRA) is a personal savings plan under U.S. law that allows you to set aside money for retirement and offers tax advantages. And while there are many different types of retirement plans to select from, the two most popular are the traditional IRA and the Roth IRA. But how do you decide what's best for you?

Whether you decide on Roth IRA, traditional IRA, or both, there are financial implications to consider. Along with IRA basics, the following are some important differences between these two retirement accounts, and other factors to consider when choosing the account that's right for you.

Roth IRA

A Roth IRA is a special type of individual retirement plan that is generally not taxed, provided certain conditions are met. Roth IRAs provide no tax break for contributions, but earnings and qualified withdrawals are generally tax-free. So with traditional IRAs, you avoid taxes up to the contribution limit when you put the money in. With Roth IRAs, you can avoid taxes when you take it out in retirement.

Roth contributions (not earnings) can be withdrawn penalty- and tax-free anytime, even before age 59½. Five tax years after the first contribution, you can withdraw up to $10,000 of Roth earnings penalty-free to pay for qualified first-time homebuyer expenses.

You can make contributions to your Roth IRA after you reach age 70½ and you can leave amounts in your Roth IRA as long as you live. Also, all qualified distributions are tax-free, but as with any other retirement plans, non qualified distributions from a Roth IRA may be subject to a penalty upon withdrawal.

Traditional IRA

With a traditional IRA, you may be able to deduct some or all of your contributions from your taxable income, and may also be eligible for a tax credit equal to a percentage of that contribution. Amounts in a traditional IRA, including earnings, generally are not taxed until distributed. Amounts you withdraw from your IRA are fully or partially taxable in the year you withdraw them.

Contributions to traditional IRAs lower your taxable income in the contribution year. That lowers your adjusted gross income, helping you qualify for other tax incentives you wouldn't otherwise get, such as the child tax credit or the student loan interest deduction. You can withdraw up to $10,000 without the normal 10 percent early-withdrawal penalty to pay for qualified first-time homebuyer expenses. However, you'll pay taxes on the distribution.

You can set up a traditional IRA at any time and make contributions as long as you were under age 70½ at the end of the tax year, and you (or your spouse, if you file joint return) received taxable compensation, such as wages, salaries, commissions, tips, bonuses, or net income from self-employment.

Individual Retirement Account summary

For some, their eligibility to deduct traditional IRA contributions can be the deciding factor in choosing between a Roth and traditional IRA. However, being eligible to deduct your contribution doesn't mean that the traditional IRA is the better choice. Consider whether the benefits of the Roth IRA - such as tax-free qualified distributions - outweigh the benefits of a deduction. Finally, you may want to consider splitting your contribution between both types of IRAs and enjoy the benefits of both.

Always consult with a financial advisor or insurance professional before determining which option is best for you, your retirement planning and your financial situation.

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What is the downside of a Roth IRA?

One key disadvantage: Roth IRA contributions are made with after-tax money, meaning that there's no tax deduction in the year of the contribution. Another drawback is that withdrawals of account earnings must not be made until at least five years have passed since the first contribution.

Should I have a Roth and traditional IRA?

It may be appropriate to contribute to both a traditional and a Roth IRA—if you can. Doing so will give you taxable and tax-free withdrawal options in retirement. Financial planners call this tax diversification, and it's generally a smart strategy when you're unsure what your tax picture will look like in retirement.

Which type of IRA is best for me?

Retirement experts often recommend the Roth IRA, but it's not always the better option, depending on your financial situation. The traditional IRA is a better choice when you're older or earning more, because you can avoid income taxes at higher rates on today's income.