Know The Differences Between Traditional and Roth IRAs

IRA stands for “Individual Retirement Account”. These accounts are traditionally used by individuals who either don’t have a 401(k) or are looking for supplemental retirement savings in addition to what they save through their place of work.

There are two major kinds of IRAs: a Roth IRA and a Traditional IRA and this article will give you a sense of which might be right for you.

Traditional IRAs

The most important aspect of a traditional IRA is that it is pretax, and your contribution tax-deductible. This means that when you put money into this kind of fund, the money that you put in is not taxed at that time. Here are some important facts about Tradition IRAs:

1. Pretax: Traditional IRAs are taxed at the time of withdrawal. This means that when you have retired and are withdrawing from your accounts, whatever tax bracket you find yourself in while you are retired will apply to your withdrawals from your IRA.
2. Tax deductible: Your contributions could potentially lower your taxable income for the year that you are contributing, which may result in various tax benefits that you may not have had access to otherwise.
3. Required Minimum Distributions (RMDs): When you reach a certain age you will be forced to withdraw a minimum amount of your traditional IRA. You cannot leave your funds in this kind of account indefinitely, even if you don’t need the money.

Roth IRAs

A Roth IRA is much more like a regular investment account, though it has a few additional upsides. Here are some important details about Roth IRAs:

1. Post-tax: A Roth IRA is funded by post-tax contributions. This means the money that you are contributing has already been taxed and will not be taxed again. This is a key difference between a traditional IRA and the Roth IRA. A traditional IRA or investment account is subject to taxes on withdrawal, whereas a Roth IRA is withdrawn tax-free
2. Not tax deductible: Contributions to your Roth IRA are not tax deductible.
3. No RMD: Roth IRAs do not have Required Minimum Distributions. You can leave the money in the account to your beneficiaries if you desire, but they will be subject to an inherited IRA RMD rule. But still, you are not required to make any withdrawals to this account during your lifetime.

Tax Brackets

Knowing which of these IRAs to use depends on which tax bracket you will be in during your career and retirement.

If you think that you will be in a lower income tax bracket during your retirement than you are while you are working, a traditional IRA can be a great way to minimize the impact taxes have on your income. The reverse is true of a Roth IRA: if you think that tax rates will increase or that you will have a higher income tax bracket when you are retired than you do now, the Roth can be a great option.

There are many factors to consider when it comes to deciding the kind of retirement fund you want to use. If you have questions about which one might be right for you, please reach out to us for a complimentary review of your finances today.