Investing in your retirement is one of the best choices you can make for your future and that of your loved ones. Individual Retirement Accounts (IRA) are one of the best tools available to help grow your savings.
There are two common types of IRAs – traditional and Roth. While both share similarities, each offers different benefits that can help you on your unique goals.
The main difference between traditional and Roth IRAs is when and how dollars are taxed. The simplest way to think about them is that with traditional IRAs, you pay for taxes later – in retirement – and with Roth IRAs, you pay for taxes today.
Both IRAs have the same annual contribution limit. For most individuals, the total amount you can put away, in 2024, is $7,000 a year. Those 50 or older can add a $1,000 catch-up contribution. Individuals can have both a traditional and Roth IRA, but the total contribution limit will still be $7,000 annually, as of 2024.
Both IRAs also have a 10% tax penalty on funds withdrawn before age 59½, a disincentive added to the regular income tax you would have to pay. Those with a traditional IRA would pay the penalty in addition to the regular income tax, should a premature withdrawal occur.
Reasons to consider a traditional IRA
With a traditional IRA, you can add pre-tax dollars or fund it with after-tax dollars deducted from that year’s earned income. Either way, your investment grows tax-deferred, so when you enter retirement and begin withdrawing money from that traditional IRA, that money is taxed as income.
Traditional IRAs can be helpful if you need to lower your current taxable income. If you met the contribution limit in 2024, that is the amount by which you could lower your taxable income.
Traditional IRAs have a Required Minimum Distribution (RMD) each year beginning at age 73 – meaning you must withdraw a certain amount of cash. Failure to take out your RMD will mean a 50% tax on the amount not withdrawn.
Reasons to consider a Roth IRA
You fund a Roth IRA with after-tax dollars, so the amount you add today is not tax deductible, and now you see it grow tax-free. Better yet, you get to withdraw that money tax-free in retirement.
As of 2024, if you’re single and earn less than $146,000 or a married couple filing jointly earning less than $230,000 per year, a Roth IRA may be an option to start saving for retirement.
Another feature of the Roth IRA is there is no required minimum distribution in retirement once the account reaches five years. The money is yours, tax and penalty-free, so long as you’ve had the IRA for at least five years.
Which is better?
It depends on your own personal finances. A traditional IRA is not necessarily better than a Roth IRA; it’s about which will suit you better today, tomorrow, or later in life. Everyone’s financial situation is unique, so speaking with your financial consultant is wise.