A traditional IRA has back end taxes requiring you to pay taxes when you make withdrawals in retirement. In a Roth IRA, you pay taxes on contributions made to your account; you don’t have to pay any taxes when you take distributions in retirement. That’s the basic difference between a Roth and traditional IRA. Let’s compare and contrast a little more in detail.
Anyone under 70 ½ years of age and with a taxable income can invest in a traditional IRA.
Anyone drawing a taxable income can open a Roth IRA; there are no age limitations for funding the account.
For both traditional and Roth IRAs, the contribution limit is $5,500 for individuals aged under 50, and a catch-up amount of $1,000 for a total of $6,500 in maximum contributions for individuals aged 50 years and above.
The tax deductions for a traditional IRA contribution is phased out for individuals with a workplace retirement plan and a modified gross adjusted income between $61,000 and $71,000, and $98,000 to $118,000 for couples. Those who don’t have a retirement plan at their place of employment but are married to someone who’s covered by a work plan, the deductions are phased out if the couple’s income is between $183,000 and $193,000.
For individuals, the income limit for contributing to a Roth IRA is between $116,000 and $131,000; for married couples, the limit is between $183,000 and $193,000.
- Contributions to a Roth IRA are not tax deductible.
- Deductions will depend on factors such as your income, filing status, whether you are covered by a 401(k) or 403(b) retirement plan at
- your workplace, and if you get Social Security benefits.
- In a traditional IRA, withdrawals are taxable, with a penalty imposed on distributions taken before the age of 59 ½.
- In a Roth IRA, an original contribution is distributed tax and penalty free. If you are 59 ½ years or older, and if the IRS’s five year aging requirement has been met, then no tax is applied to earnings.
- A 10 per cent penalty is charged for early withdrawal.
Should you opt for a Roth or traditional IRA?
An understanding of the key differences between a Roth and traditional IRA can help you decide the better plan of the two for your circumstances. Generally, it makes more sense to stay in a traditional IRA if you expect to be in a lower tax bracket upon retirement. This way, when you start making withdrawals after retirement, you’ll be paying lesser in taxes. On the other hand, if you expect to be in the same or higher tax bracket upon retirement, a Roth IRA is the better option.
If you’re not fully sure about what tax bracket will apply to you in the future, you can consider a tax diversified retirement savings strategy. For instance, if you are participating in a tax-deferred 401(k) plan offered by your employer, you can choose a Roth IRA for a mix of tax-free and taxable accounts. The difference between a Roth and traditional IRA will also matter if you don’t want to lock your money for a long time and desire the flexibility to make a withdrawal when you need it.