What Are the Differences Between a Traditional and Roth IRA

by costumeideas

What Are the Differences Between a Traditional and Roth IRA: Despite the fact that both are called IRAs, there are a few significant differences between that need to be understood.

Traditional and Roth IRAs are common tools used to save for retirement.

Each has unique tax benefits that may help accelerate investment growth far beyond what is generally possible via traditional taxable accounts.

Despite the fact that both are called IRAs, there are a few significant differences between that need to be fully explored before committing deciding on one versus the other.

Key Differences Between Traditional and Roth IRAs

Taxation

Perhaps the biggest difference between a Roth IRA and a Traditional IRA is the way that contributions and earnings are taxed.

Any contributions made to a Roth IRA are made with after-tax dollars. Furthermore, you cannot claim a tax deduction for these contributions. Since you have already paid tax on any money that you have contributed to your Roth IRA, the funds in this account are free to grow tax-free forever.

In theory, these funds have no limit on how large they can grow without having to ever pay a penny in tax again.

On the other hand, contributions to Traditional IRAs are made with pre-tax dollars. Furthermore, these contributions qualify for a tax deduction in the year they are made. Investments in a Traditional IRA grow on a tax deferred basis. No tax is due until you begin making withdrawals. Withdrawals from Traditional IRAs are taxed at the individual’s ordinary tax rate.

Mandatory Withdrawals

Another major difference between these two forms of retirement accounts are the varying IRA withdrawal rules.

When it comes to funds invested into Roth IRAs, there are no mandatory withdrawal rules. An investor is free to leave their money into the account, and allow it to grow tax-free, as long as they want. Investors are even allowed to leave it to their heirs.

Traditional IRAs, however, have a completely different set of guidelines when it comes to taking withdrawals. If you have a Traditional IRA, you must start taking distributions by April 1st following the year in which you turn 70 ½.

The IRS code specifically outlines how much you are required to take, known as the required minimum distribution, via a complex formula that takes into account your age, life expectancy, and account balance.

Additional Roth IRA Resources

The Gospel of Roth: The Good News About Roth IRA Conversions and How They Can Make You Money

THE ROTH CONVERSION OPTION if you follow my advice in the next few pages, you may increase your retirement spendable assets by over 40 percent! Everyone should 1 convert all ...

$19.58  $2.25
The Complete Guide to IRAs & IRA Investing: Wealth Building Strategies Revealed

As more and more baby boomers prepare to retire and as people seem to be retiring at an earlier age, the importance of saving for retirement has become increasingly apparent. ...

Only $10.38

Early Withdrawals

Regardless of the type of IRA you ultimately use, your contributions should be earmarked for retirement and not withdrawn before you reach retirement age. In order to ‘encourage’ investors to keep their money invested, the IRS typically assesses a 10% penalty on any withdrawals made before the account holder turns 59 ½ (see exceptions below).

Unlike contributions made to a Traditional IRA, those made to a Roth have already been taxed. As such, these contributions can be made tax-free at any time (the 10% penalty made still apply).

How Can an Investor Avoid Paying the 10% Early Withdrawal Penalty

There are a few circumstances where the IRS will waive the 10% early withdrawal penalty.

  • Qualified higher education expenses
  • Qualified first home purchase
  • Major medical expenses
  • Long-term unemployment expenses
  • Permanent disability
  • Part of a substantially equal periodic payment plan

Income Limits

According the IRS Publication 590, not everyone qualifies to participate in a Roth IRA. If your adjusted gross income exceeds a certain amount, the maximum amount that you can contribute may be reduced, or even eliminated completely.  

Final Thoughts

While it is certainly true that both Traditional and Roth IRAs can be effective tools to save for retirement, it is important to consider your personal circumstances before choosing one over the other.

Roth IRA Investments

Roth to Riches: The Ordinary to Roth IRA Handbook

Only $2.0
The Bull Truth - How to tell when your financial advisor is lying and NEVER let it happen again!

Escape dishonest financial advisors' tactics that keep you from investing successfully. The Greatest Lie in Finance is the Lie of Omission Discover - investing tricks that the ...

Only $80.0
Updated: 05/02/2012, costumeideas
 
Thank you! Would you like to post a comment now?
2

Comments

Only logged-in users are allowed to comment. Login

You might also like

July 15th 2013 The Hostess Twinkie Makes The Sweetest Comeback...

Hostess will be back and the stock and on your local store shelves this July ...

Best Money Saving Tips

Effective money saving tips which are common sense but useful.


Disclosure: This page generates income for authors based on affiliate relationships with our partners, including Amazon, Google and others.
Loading ...
Error!