I get asked this question quite a bit when talking about retirement plans. First, let’s talk about some of the similarities between a Traditional IRA and a Roth IRA. Both are types of retirement vehicles and they both have a wide variety of choices when investing the funds. Those choices can range from mutual funds, stocks, bonds, ETF’s, Annuities, CD’s, and even certain vehicles that invest in cryptocurrency. Both retirement vehicles have the same limits for contributions each year. For 2019, its $6,000 per year if you’re under 50 years old and $7,000 a year if you’re over 50 years old.
Now, the differences between a Traditional IRA and a Roth IRA revolves around how the contributions and distributions are taxed. Let’s discuss the contribution side first. For a traditional IRA, you are contributing an amount up to $6,000 or $7,000, you will get a tax deduction based on your tax bracket and the amount of your contribution. For instance, if you contributed $6,000 and your tax rate was 20%, you would actually get a deduction of $1,200 on your tax taxes for the same tax year of your contribution. Now, for a Roth IRA, you are contributing up to the $6,000 or $7,000 a year, you won’t get any kind of tax deductions because a Roth contribution is made after taxes. Why would anyone want to do the Roth IRA if you don’t get a deduction?
Here’s the reason…
When you are in retirement and are ready to start taking distributions, the Traditional IRA is taxed at your, then current tax rate. Your investments grew over the years tax deferred, but you do have to eventually pay the taxes on the contributions and the growth of those contributions when you take a distribution. In a Roth, when you are ready to start taking distributions, you pay zero taxes. That’s right, you don’t have to pay a dime in taxes. The biggest advantage the Roth has is your money will grow over time tax deferred and you get to take that money out without having to pay taxes on that money. Roth IRA’s actually benefit those who have several decades for their funds to grow. That doesn’t mean if you’re in your 40’s or even 50’s that you can’t take advantage of this vehicle. Another advantage to the Roth IRA is that there is no age limit on contributions. You can keep putting money in there as long as you want. Traditional IRA’s require you to start taking what’s called Required Minimum Distributions at age 70 1/2 currently. Its possible lawmakers vote to move the age up in the near future. For right now, you cannot make a contribution to a Traditional IRA once you have reached the designated Required Minimum Distribution age. Some people will even take their RMD’s and put into a Roth IRA.
The Roth IRA seems to be a widely misunderstood retirement vehicle that is greatly underutilized. People seem to like the tax deduction now idea of the Traditional IRA rather than the no tax later idea of the Roth IRA. Usually by the time people start to like the concept of the Roth IRA, they have lost out on a tremendous amount of time those funds could have been growing tax deferred. If you don’t have a Roth, you need to look into it. It could be the difference in tens of thousands of dollars in your retirement.
There are certain restrictions to both types of IRA’s, far too many to explain in just one article. Before you make any decisions, you should talk to your tax professional and your advisor to make sure you are choosing the best option for your situation.