Learn the differences between these two types of retirement accounts to figure out how you can put one – or both – to work for you.
IRAs are tax-advantaged accounts intended to help you save for retirement. The money you contribute to an IRA can be invested in mutual funds, stocks, bonds, ETFs, certificates of deposit (CDs), or annuities. Your rate of return will depend on the performance of the investments you select for your retirement account.
With a Traditional IRA, you may be able to deduct your contribution from your taxable income, thus reducing current federal income taxes. This depends on your income, your tax filing status, and if you or your spouse are covered by a retirement plan at work. While your money grows, taxes are deferred. You will be subject to ordinary federal income taxes when you withdraw the money, generally at retirement.
With a Roth IRA, you cannot deduct your contribution from your income for federal income tax purposes. However, your contributions can always be withdrawn tax-free and qualified withdrawals of earnings are free of federal income tax. If you withdraw earnings before the account has been open at least five years and before age 59½, you are generally subject to federal income taxes and a 10% penalty on the amount of earnings withdrawn. Earnings withdrawn before five years but after age 59½, are generally subject to federal income taxes but no penalty.
Here’s a side-by-side comparison of the two types of accounts:
|Traditional contributions||Roth contributions|
|Taxes deferred||Taxes paid upfront|
|Taxable when withdrawn||Tax-free earnings when withdrawn|
|Tax-deferred growth||Tax-free growth|
|Contributions are generally tax deductible||Contributions are not tax deductible|
|May reduce your federal income tax||Contributions are always withdrawn tax-free|
|Qualified withdrawals are taxable||Qualified withdraws are tax-free|
While this discussion of the tax treatment and tax advantages of different retirement accounts is intended to provide valuable information, it is not a substitute for professional tax advice and you may want to consult with a tax advisor to determine the best options for your situation.