The primary difference between traditional and Roth IRAs is in the tax treatment of your deposits to and withdrawals from these retirement plans. The money you deposit in and earn on your traditional IRA is not taxed as income until you withdraw the funds. Deposits to a Roth IRA are not tax deductible, forcing you to use after-tax income to build up your balance. However, qualified withdrawals, including deposits and earnings, from Roth IRAs are tax-free.
Tax Bracket Decisions
Traditional IRAs allow pretax contributions but are taxable as ordinary income when you withdraw monies. Roth IRA deposits are after-tax contributions but qualified withdrawals are not taxed. Therefore, although many people fall into higher tax brackets when they are working, Roth IRAs make great sense if you anticipate a high or higher tax bracket upon retirement, since your withdrawals will not be taxed.
Tax Treatment Changes
IRA tax regulations can change whenever Congress passes laws that control IRA tax treatment and age or income rules. Understand that the tax rules that apply to both traditional and Roth IRAs when you open them may or may not apply when you withdraw funds at retirement. Investing long-term with either traditional or Roth IRAs carries this risk of changes in tax treatment, economic conditions and, in some cases, contribution or income maximums.
Traditional IRAs have no income limits to make contributions, except that you must have employment compensation or, if a joint IRA, you or your spouse has wages. Roth IRAs, however, have some income limitations. Single tax filers in 2013 can earn up to $112,000, while joint filers can have up to $173,000 in income. Single filers earning between $112,000 and $127,000 can make what's called partial contributions. Joint tax filers earning $178,000 and $188,000 qualify to make partial contributions.
Important Date Differences
You can withdraw funds from either a traditional IRA or a Roth IRA when you turn 59 1/2 years old without penalties. If you wait, by the time your 70 1/2 years old, you must begin withdrawing funds from a traditional IRA. Roth IRAs have no required distributions during your lifetime. However, there is an additional requirement with a Roth IRA: Your Roth IRA must be open for at least five years before you withdraw funds, regardless of your age.
Along with different tax treatments, traditional IRA and Roth IRA accounts vary depending on the banks, credit unions or investment firms offering them. For example, banks and credit unions typically offer a savings account and certificate of deposit options to generate IRA earnings. While the interest rates and earnings are guaranteed, bank and credit union earnings may be lower than the mutual fund or similar accounts investment firms offer. There is risk of loss with investment firm accounts, but these accounts have a higher upside than low risk, low interest bank and credit union IRA certificates.
- Jupiterimages/liquidlibrary/Getty Images