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A Roth IRA and a traditional IRA (individual retirement account) offer valuable retirement planning benefits, but with different structures, income limits, and pros and cons.
How the Traditional IRA Works
A traditional IRA helps you save for retirement and can give you a tax break today. For example, if you contribute $4,000 to a traditional IRA this year, you may be able to deduct that amount on your tax return. This allows you to enjoy a nice break from your obligation to the IRS – subject to income limitations – while your investment continues to grow. Your money grows tax deferred until it is withdrawn.
You can continue to contribute money each year up to the annual contribution limit: $7,000 for people under 50 and $8,000 for people over 50 in 2024.
You can start making penalty-free withdrawals at age 59 1/2, and you must start making withdrawals at age 73. However, when you start withdrawing money, you pay taxes on the deductible contributions you made and the investment. profits.
How the Roth IRA Works
While a traditional IRA defers your taxes, a Roth IRA is not designed to give you immediate tax benefits. So if you decide to contribute $4,000 to a Roth IRA this year, it’s all after-tax money. The benefits emerge if you start withdrawing at age 59.5 or later; You get to keep all the compound growth that has built up over the years tax-free.
The annual contribution limits are the same as a traditional IRA: $7,000 for people under 50 and $8,000 for people over 50 in 2024.
However, there is no time stamp for when you need to make these withdrawals. You can wait longer to access the cash, and if you wish, you can leave the money in the Roth IRA forever and pass the money on to your estate plans – income tax free.
Insights into bank rates
You can have either a Roth IRA or a traditional IRA. As long as you meet the government’s qualifications, you can put both investment vehicles to work and enjoy a balance of tax benefits now and years into the future.
Roth IRA and Traditional IRA: Key Differences
The main distinction between Roth IRAs and traditional IRAs involves two major considerations: taxes and timing.
Traditional IRAs offer the opportunity for tax deductions in the present, while Roth IRAs are created with after-tax dollars (meaning there is no benefit in the here and now). Then, when you withdraw money in the future after age 59.5, traditional IRAs incur tax liabilities on anything that isn’t taxed (deductible contributions and investment earnings), while Roth IRA withdrawals are tax-free.
Both IRAs are good choices that will help you prepare for the future. It’s up to you when you reap the benefits: now or later.
A common part of the Roth IRA vs. Traditional IRA conversation is the assumption that you will be in a lower tax bracket in retirement. While that is possible, it is true impossible to accurately predict your tax bracket decades later. Instead, think of the road to retirement as a ski slope. Think of your savings as a snowball rolling down the slope: you want it to get bigger and bigger as it reaches the bottom.
With that image in mind, it’s important to ask yourself a question: Do you want to spend some of it on taxes when you’re finally ready to leave the job market, or would you rather keep that whole snowball to yourself? With a Roth IRA, you’ll meet your tax obligation at the top of the hill when the snowball is the size of your fist. At the bottom of the hill it is the size of a car. Consider it a way to thank yourself later: you paid the taxes early so you can enjoy that whole car-sized chunk of money.
If you’ve been contributing to a traditional IRA all these years, the government is waiting for its cut.
Breaking down the differences
| Roth IRA | Traditional IRA |
|---|---|
| After-tax contributions (no tax benefit today, but tax-free withdrawals in retirement) | Pre-tax contributions (now a tax benefit, subject to income limits, but your contributions and all growth are taxed as income in retirement) |
| Never required to withdraw money; can be passed on in estate plans | Must start withdrawing from age 73 |
How to Check Your IRA Eligibility
If you or your spouse have earned income from a job, you have checked the first box to qualify for the IRA. However, to take advantage of the tax benefits of an IRA, you must make sure you meet additional government requirements. Income thresholds vary widely based on a few key factors: your filing status, how much you’ll earn this year, and whether you also have a workplace-based retirement plan.
For example, if you are a single person or head of household in 2024 and are covered by a workplace retirement plan such as a 401(k), you must earn less than $77,000 (modified adjusted gross income) to take the full deduction. a traditional IRA. If you are married and earn $240,000 or more, you cannot contribute to a Roth IRA. Be sure to check out the The IRS’s updated contribution limits and deduction requirements to verify that you can enjoy the full benefits of an IRA.
And if you’re concerned about income limitations, you might consider setting up a backdoor Roth IRA, which comes with some additional complications but may be worth it for high-income taxpayers.
Other Considerations
Here are some additional factors to consider when comparing a Roth IRA and a traditional IRA.
Your current age: If you’re earlier in your career, comparing the benefits between a Roth and a traditional IRA is especially important. The longer you have between now and retirement, the more the prospect of compound tax-free growth in a Roth IRA stands out as a big differentiator.
Your family history: Although retirement is often discussed around the traditional age of 65, it is important to note that people are working longer – and will continue to do so in the future. If you have longevity in your family and can imagine a retirement stretching well into the 80s or 90s, a Roth IRA’s lack of withdrawal requirements may be especially important.
You can have both: When comparing Roth to traditional IRAs, you should know that this is not an either-or comparison. Provided your annual contributions can stay within the government’s guardrails, you can put both investment vehicles to work and enjoy a balance of tax benefits now and years into the future.
How to Choose the Right IRA for You
Regardless of how you decide to divide your money between a traditional IRA or Roth IRA, it’s important to compare options to diversify your investments with an approach tailored to your risk tolerance and your retirement timeline.
If you want to have full control over investment decisions, look for companies that offer you a full range of educational offerings about the market and potential places to grow your money. If you’d rather put your IRA on cruise control, a target-date retirement fund or robo-advisor that can deliver sophisticated, low-cost investments tailored to your needs is an easy way to save.
A financial advisor can also help you decide whether a Roth or a traditional IRA makes sense for you and your goals. Bankrate’s financial advisor matching tool can be a great way to find an advisor near you.
Traditional IRA: Pros and Cons
Plus points
- You may now be able to enjoy a tax deduction: The biggest benefit of contributing to a traditional IRA is tax time. Depending on your income, you may be able to deduct your contributions from your taxes each year to lower your annual income and reduce your financial obligations to the government.
- You can defer your tax assessment on your income: While that money grows, you don’t have to worry about paying taxes on it in the meantime. That will happen when you retire, and you’ll only pay taxes on money that hasn’t been taxed before: any contributions you’ve been able to deduct on previous tax returns, along with investment earnings.
Cons
- You pay taxes along the way: You may have enjoyed tax benefits at a younger age, but those benefits don’t last forever. You pay the tax man on the back end, which means these withdrawals are split between you and the government.
- You are obliged to withdraw the money: You may not be sure what you’re going to do at age 73, but one thing is certain with a traditional IRA: you’re going to have to start taking some money out. At this point you will start performing the required minimum withdrawals. That minimum amount is determined by an IRS formula that includes the current value of your account and your life expectancy.
- You’ll likely pay early access penalties: If you withdraw funds early, these funds will be considered toward your annual taxable income and you will likely pay an additional 10 percent penalty. There are some exceptions to the rule – for example, using the money to cover medical bills, unemployment issues, or a down payment on a first home – but you would still want to use this money as a last resort.
Roth IRA: Pros and Cons
Plus points
- You can keep your recordings: Because you pay taxes on your contributions up front, a Roth IRA gives you the great benefit of tax-free growth. No additional taxes are levied on the income.
- You never have to record anything: There is no requirement to take money out of a Roth IRA at any age. Instead, if you wanted to, you could leave this money for longer, or you could leave it forever and give it to an heir or charity tax-free.
- You can withdraw your premiums at any time without penalty: Because you’ve already paid your taxes on your contributions, there is no early withdrawal penalty to withdraw what you contributed with Roth IRAs.
Cons
- There are no upfront benefits: Because your contributions are made after-tax, you won’t feel any immediate tax satisfaction from a Roth IRA.
- The convenience of early withdrawals can be tempting: It can be useful to be able to draw on your pension fund, but it is not a wise move. The early withdrawal of these contributions is also one-way traffic. You won’t have to make additional contributions in later years to make up for the money you withdraw.
