Opening an individual retirement account (IRA) is an important step in meeting your retirement saving goals. An IRA enables you to invest your money and enjoy tax benefits. IRAs can be particularly helpful if you don’t have access to an employer-sponsored retirement plan. The hardest part of starting to save may be determining the type of IRA that’s best for you – Roth vs. Traditional IRA.
The biggest difference between the Roth and Traditional IRAs is how and when you get a tax break. The first question you should ask yourself is whether you think your tax rate will be higher or lower in the future. There’s an upfront tax break that comes with a traditional IRA. If you think your tax bracket will be lower at retirement, this might be your best bet. If you think it will be higher when you withdraw, then a Roth IRA may be a better bet. Read on to learn more.
Difference between Roth vs. Traditional IRA
|Roth IRA||Traditional IRA|
|Contribution limits (2021)||Under age 50 $6,000
Age 50+ $7,000
No age limit on contributions.
|Under age 50 $6,000
Age 50+ $7,000
No contributions can be made after 70 ½ years of age.
|Single tax filers with modified adjusted gross income below $139,000.||Anyone with earned income can contribute, but tax deductibility is based on income limits and whether you can participate in an employer retirement plan.|
|Taxes||Contributions are made with after-tax dollars.
Withdrawals of contributions are tax-free at any time and withdrawal of earnings are tax-free after age 59 ½
|Contributions may be tax-deductible.
There are income limits depending on whether you are covered by an employer retirement plan or not.
Funds are subject to taxes upon withdrawal.
|Withdrawal rules||More flexible. Withdrawals of contributions are allowed anytime without penalty. Distribution of earnings is penalty-free if age 59 ½ or older and account is at least 5-years old.
Early withdrawal is subject to a 10% penalty except for certain qualified exceptions.
|Mandatory withdrawals after 70 ½ years old.
Distributions before age 59 ½ are subject to a 10% penalty.
|Deadline for contributions||April 15 of the following year||April 15 of the following year|
IRAs can give workers more investment options and greater control over how their funds are managed. The upfront tax benefit you receive is the biggest advantage of a traditional IRA for most investors. The money you invest has not been taxed. Individuals in higher income brackets may find it attractive to take this tax benefit now and then hope they are in a lower tax bracket in retirement. By contrast, if you meet the income requirements for a Roth IRA and expect to be in a higher income bracket when retiring, paying taxes now may be your better bet. Since your contributions have already been taxed, withdrawals in retirement would be tax-free. As we mentioned above, your tax bracket should be a top consideration when determining which is better for you, Roth IRA vs. Traditional IRA. A Roth IRA is also a better choice if you want the flexibility of withdrawing before retirement for things such as your first house or your child’s college tuition.
Finally, you are allowed to have both types of IRAs. It’s important to remember that your income between both accounts is capped to the total contribution limits we mentioned above. For example, if you are an investor under 50 years of age, you are capped at a $6,000 split between both your accounts.
Choosing Roth vs. Traditional IRA
Ultimately, which type of retirement account you choose comes down to your future tax bracket and your current income. Whatever you choose will help you set up a good path for retirement. Understanding the pros and cons of each option can help you better prepare. This is just an overview, and we recommend you speak to a financial professional to help you decide which IRA works best for your individual circumstances.
Tap to learn more about retirement account options at Choice One Credit Union. Choice One offers both Roth and Traditional IRA account options. Speak to a Choice One representative or consult a tax advisor for more information.