Traditional IRAs vs. Roth IRAs
Traditional IRA and Roth IRAs are two retirement savings plans that are similar in some ways, but also quite different.
With a Traditional IRA, the amount that you put into the IRA is deductible from your taxable income. However, you do have to pay taxes on the money when you start to withdraw it in retirement. With a Roth IRA, you don’t get a tax deduction when you put in money, but when you start to withdraw it in retirement it’s tax-free. Both accounts are held with a custodian, and the money is invested in stock and bond index funds.
With Traditional IRAs:
- You get an immediate tax benefit on the money you contribute.
- You pay taxes on the money when you withdraw it in retirement.
- You can get a tax deduction for your contribution.
- You choose where your money will be invested.
With Roth IRAs:
- You don’t get an immediate tax benefit on the money you contribute.
- You don’t have to pay income taxes on the money when you withdraw it in retirement.
- You don’t get a deduction for your contribution.
- You can’t choose where your money will be invested.
When a Traditional IRA Makes More Sense
In general, contributing to a Roth IRA can be a smart move … provided you qualify based on income. It allows you to save money for retirement without paying income tax on your contributions. However, if you’re not eligible to contribute to a Roth IRA, that doesn’t necessarily mean that contributing to a Traditional IRA is the way to go. You could come out ahead contributing to a Traditional IRA instead of a Roth IRA.
If your current tax bracket is higher than it will be in retirement or you’re unlikely to earn more money in the future than you do now, you’d probably be better off contributing to a Traditional IRA in lieu of a Roth. Here’s why.
If you qualify for a Roth IRA but contribute to a Traditional IRA instead, you avoid paying income tax on your contributions. But you also avoid paying income tax when you withdraw your money during retirement. Contributing to a Traditional IRA instead might actually cost you less.
Bonus tip: If you don’t meet the income requirements for contributing to a Roth IRA, there are still ways to lower your taxable income … through tax deductions. Tax deductions are essentially financial benefits that you receive by reducing your taxable income.
When a Roth IRA Makes More Sense
Many taxpayers, especially young savers, are first introduced to retirement accounts such as the 401(k) and the traditional IRA. They discover, however, that neither one of these accounts makes sense for their situations.
Young savers, especially, need to understand that starting the Roth IRA is a good way to save for their retirement.