Financial Literacy Friday: Traditional vs Roth IRA
Welcome to another edition of Financial Literacy Friday! Today we’re going to discuss the difference between Traditional and Roth IRA’s (Individual Retirement Accounts). While IRA’s are commonplace, there can be some confusion between Traditional and Roth accounts, and which type is best for your situation. The goal for today is go into the differences between these two accounts so you can begin to think about which account may be better for you.
Roth IRA
Roth IRA’s allow you to contribute after-tax dollars to a retirement account that will grow tax free and can be withdrawn without paying any tax. For those who are younger and in a lower tax bracket and think that they’ll be in a higher tax bracket when they’re ready to retire, this is a great vehicle to use as you’ll pay taxes on the money at a lower level and have the money back tax free when it may be subject to higher taxes otherwise. However, if you withdraw the money early there can be a penalty unless it’s for a qualified expense. Some other characteristics of a Roth IRA are:
You can continue contributing to it as long as you have earned income, there is no cutoff point.
You can maintain the account indefinitely as there are no required minimum distributions (RMD’s)
Eligibility for a Roth account is dependent on income, so the limit at which you can no longer contribute is $199,000 for a married couple and $135,000 for single filers. Your income also determines how much you’re able to put into this account.
Let’s take a look at Traditional IRA’s before we get into the differences between the accounts.
Traditional IRA
The Traditional IRA allows you to put pre-tax income into the account, where it will grow tax deferred and will taxed as normal income when it’s taken out. Unlike the Roth account, contribution limits are based on age not income with the current limits being $5,500, with higher limits after you reach age 50 where the limit increases to $6,500. When you reach 70.5 years old, you’re no longer able to contribute to the Traditional IRA. While you may start taking money out at 59.5 years of age, you are required to start taking RMD’s (required minimum distributions) at 70.5 years of age. While there are certain exemptions, there are penalties for taking money out before you reach 59.5.
Differences
The main difference between these two accounts is the tax treatment of the money you put into them. With Roth accounts you pay the tax up front and get it later without any tax, whereas with Traditional you put the money in tax free and pay taxes when it’s withdrawn. For Roth accounts, the eligibility is based on your salary, and some high earners may not be able to have access whereas Traditional eligibility is based on your age and there are contribution limits depending on what age you’ve attained. The other major difference is that with a Roth you can maintain the account indefinitely without taking any distributions, whereas with the Traditional you must start taking distributions at 70.5 years of age.
These are the basic differences between these two accounts, which should shed some light on how they may or may not be advantageous to you. There are smaller differences and other wrinkles, but if you’re curious about these or want to learn which may be better for you, comment or contact me and we can discuss your personal situation.
