An IRA is an Individual Retirement Account. It is a great way to save for retirement, and comes with some restrictions and benefits. The following is a look at the difference between a Traditional IRA and Roth IRA.
When you have a traditional IRA, you get your tax deductible contributions based on your income level. The lower the income, the more you can contribute.
A traditional IRA allows you to begin taking withdrawals at age 59 ½, and mandates that you start taking them at age 70 ½.
With a traditional IRA, you pay your taxes on earnings when you withdraw from your IRA. So, if you withdraw 30k in a year, you pay the taxes on that much. If you withdraw more you pay more. Thus, if you make a great amount of money contributing to an IRA, and deferring the taxes can be really helpful tax wise.
You can use funds from your traditional IRA to purchase a variety of investments, including stocks, bonds, certificates of deposit, etc. Which means it is a tax deferred money that can be invested to earn more tax-deferred money.
A traditional IRA is available to everyone; there are no income restrictions.
All funds withdrawn, including your principal contributions, before 59 1/2 are subject to a 10% penalty. There are a few exceptions, such as college tuition.
For a Roth IRA your contributions are not tax deductible. This means you pay taxes on them before you put them in your account.
There is no mandatory distribution age. This means that you don’t have to start taking it at 70 ½.
Because you pay taxes on money before you invest it in an IRA, your earnings and principal are tax free as longs as the rules and regulations are followed.
Like a traditional IRA, funds can be used to purchase a variety of investments.
There are income restrictions. If you are filing your taxes singly you can’t make more than $95,000, and if you are filing joint, your combined income can’t be more than $150,000 annually.
Principal contributions can be withdrawn any time without penalty.
So, the biggest difference between the traditional and roth IRA is how it is treated for taxes. Tax deferred is one term, and tax-free is another. When you invest money in a traditional IRA, you get to subtract that amount from your taxable income. However, when you start withdrawing funds, you pay taxes on all of the capital gains, interest, etc. With a Roth IRA, if you invest money in it, you still pay the income tax, you don’t get a deduction, but when you start withdrawing, your money is 100% tax-free.
So, if you do not exceed the income limitations, the Roth IRA is actually a much better choice, as it allows you tax free earnings from your Roth IRA contribution investments, etc.