Roth IRA vs. Traditional IRA

IRAs in general, and the Roth IRA in particular, is a vast subject and many books have been written on it.

With these recent posts, I am trying to simplify this complicated issue and I hope that you are able to benefit from this attempt to clarify matters connected to Roth IRAs.

If you have been following my earlier posts, you probably have a fair idea of what a Roth IRA is and the general rules that govern it.

Since the Traditional IRA has been around for a longer time, people are more familiar with that, and a natural question would be what is the difference between a Traditional IRA and a Roth IRA?

This is what we will look at today.

Tax Deduction

The eligibility for a tax deduction is the first and most significant distinction between a Traditional IRA and a Roth IRA. Contributions made to a Traditional IRA are tax deductible while those made to a Roth IRA are not.

Thus when you are contributing to a Traditional IRA you are able to get a tax deduction which benefits you by reducing the cost of the contribution itself. By contrast, Roth IRA contributions are made from income that has already been taxed so you don’t enjoy any deductions when you make contributions.

Tax benefits in a Roth IRA accrue only when a person actually attains retirement age, as an early withdrawal of anything other than your contributions will trigger penalties and taxes.

As an example, if you make a contribution of $2000 a year to a Traditional IRA, then that two thousand is deducted from the total amount of taxable income. So if your annual income is $60,000 and you make a contribution of $2000, you then pay income tax on only $58,000. If you make that same contribution to a Roth IRA, you will pay tax on the full amount of $60,000 but when you eventually withdraw the amount and the money that principal earned in the intervening years will be yours tax free!

Taxes on IRA earnings

Whereas in a Traditional IRA, you pay taxes as and when you make withdrawals, in a Roth IRA, such withdrawals of the principal and earnings accrued thereon are wholly tax free so long as you follow the rules and regulations governing withdrawals from your Roth IRA. In fact with a Roth IRA, you can withdraw your principal contributions anytime, without any penalty.

The same is not true for the Traditional IRA because every withdrawal requires tax to be paid on it.

Mandatory Distribution / Withdrawal Age

With the Traditional IRA, mandatory withdrawals begin at age 59 and a half and these withdrawals are required to be continued until the age of 70 and a half.

The benefit of the Roth IRA is that it does not have this mandatory distribution age, and is therefore more flexible and adaptable to your own personal requirements.

Income Restrictions

There are no income limitations with a Traditional IRA, therefore anyone can make contributions. The Roth IRA requires that you fall within certain specified income brackets to make contributions.

If you plan on living a long and healthy life, and hopefully we all do, a Roth IRA seems to have several benefits so a person who actually reaches retirement age can enjoy tax free withdrawals in his or her twilight years.

What do you think? Have you given any thought to how you are going to plan for your retirement? Have you evaluated whether the Traditional IRA or the Roth IRA is best for your circumstances?

Let me know your thoughts.