By Cathy Peters
The type of individual retirement account you choose can significantly affect you and your family’s long-term savings. So it’s worth understanding the differences between traditional IRAs and Roth IRAs in order to select the best one for you.
Anyone with earned income and younger than 70 ½ can contribute to a traditional IRA. It may not be deductible, depending on income and whether or not it is covered by an employer plan. Roth IRAs, however, have income eligibility restrictions based on your filing status.
Both traditional and Roth IRAs provide generous tax breaks, but it is a matter of timing when you benefit from them. Traditional IRA contributions are sheltered from tax in the year the contribution is made, while withdrawals in retirement are taxed at ordinary income tax rates. Roth IRAs provide no tax break for contributions, but earnings on withdrawals are generally tax free.
One of the main factors in deciding to contribute to a traditional IRA or Roth IRA should depend on whether or not you expect your income to increase or decrease during retirement, because retirement income determines if the tax rate you pay on your Roth IRA contributions (today’s tax rate) is higher or lower than what you would pay on your traditional IRA’s withdrawals in retirement.
One major difference between traditional IRAs and Roth IRAs is when the savings must be withdrawn. Traditional IRAs require you to start taking required minimum distributions (RMD’s) at age 70 ½. Roth IRAs do not mandate withdrawals during the owner’s lifetime. If you don’t need the money, Roth IRAs can continue to grow tax-free throughout your lifetime, making them good wealth-transfer vehicles. Unlike traditional IRAs, contributions to a Roth can continue past age 70 ½ to the extent you have earned income.
Traditional IRA withdrawals may be made after 59 ½ without penalty and before 59 ½ with a penalty. Contribution dollars may be withdrawn from a Roth IRA at any time without tax or penalty. If the Roth has been held for less than 5 years and before age 59 ½, withdrawal earnings are subject to tax and penalty.
Keep in mind that Congress can change these rules at any time. While these are the rules today, they may be different when you retire.