A traditional IRA and a Roth IRA are both individual retirement accounts, but they have some key differences in terms of contributions, taxation, and withdrawal rules:
- Contributions: With a traditional IRA, contributions may be tax-deductible in the year they are made, depending on your income and participation in an employer-sponsored retirement plan. On the other hand, Roth IRA contributions are made with after-tax funds, meaning they are not tax-deductible.
- Taxation: Traditional IRA funds grow tax-deferred, meaning your contributions and investment earnings are not taxed until you withdraw them in retirement. In contrast, Roth IRA funds grow tax-free, so qualified withdrawals in retirement are not subject to taxes.
- Required Minimum Distributions (RMDs): Traditional IRAs have RMDs, which require you to start withdrawing a certain amount each year starting at age 72 (subject to change based on legislation). Roth IRAs, however, do not have RMDs during the account owner's lifetime, allowing for potential tax-free growth for as long as you prefer.
- Eligibility and Contribution Limits: Both types of IRAs have eligibility and contribution limit rules. Traditional IRAs allow contributions if you have earned income and are under the age of 72 (subject to change), while Roth IRAs have no age restriction for contributions. Contribution limits may vary over time and depend on factors such as income and tax filing status.
- Withdrawals and Penalties: With a traditional IRA, withdrawals made before age 59 ½ are generally subject to income taxes and a 10% penalty, except for certain exemptions. Roth IRAs, however, allow for penalty-free withdrawals of contributed funds (not earnings) at any time, and qualified withdrawals of both contributions and earnings can be made tax-free after five years and age 59 ½.
Ultimately, the choice between a traditional IRA and a Roth IRA depends on factors such as current tax situation, future tax expectations, financial goals, and personal preferences. It is often recommended to consult with a financial advisor or tax professional to determine the best option for your specific circumstances.