Traditional vs. Roth IRA – What’s the Difference?

Roth-IRA

The most important step in saving for retirement is simply starting. Once you decide to make that commitment, there are choices to make. There are a lot of different ways to effectively save for retirement, with one of the most common being the Individual Retirement Account (IRA).  When it comes to an IRA, there are two common options: Traditional or Roth. Both serve very similar purposes, but have differences that can meaningfully affect your total retirement balance.

The biggest and most obvious difference between the two is in the way they are taxed. With a Traditional IRA the money you deposit and invest isn’t taxed until you withdrawal the funds during retirement (it is tax deductible). As an example, say you make $60,000 and contribute $3,000 to a Traditional IRA. You would pay income tax on only $57,000 and the $3,000 would grow tax-free until you are able to withdrawal it at age 59 ½.  If you withdraw funds before then, you’ll have to pay the income tax and an additional 10% early withdrawal penalty.

Unlike a Traditional, the contributions for a Roth IRA are not tax deductible. So, in the example above, you’d pay tax on the full $60,000 of income. The good news is, once you hit retirement, any withdrawals you take are completely tax-free – including any investment gains. A Roth IRA provides the rare opportunity to avoid paying any tax on investment gains, however it is limited to those with incomes less than $110,000 for a single filer or $173,000 for a married couple.

Simply put, with a Roth you pay taxes now and a Traditional you pay later. Either can be a good option and you are welcome to utilize both, however always contribute to a employer 401(k) with a match, first!

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