Need to Know: Traditional Vs. Roth IRA

When saving for retirement, an IRA is a great way to save as it offers tax benefits, and is a vessel specifically designed to help you with retirement saving, which can often be difficult, and something people avoid thinking about. The following are the basic differences between traditional versus Roth IRA.

Roth IRA versus Traditional:
Tax deductions:
A Roth IRAs contributions are not tax deductible.
A traditional IRA contributions are tax deductible depending on the income level.

Distribution age:
A Roth IRA has no mandatory distribution age.
A traditional IRA withdrawals begin at age 59 1/2 and are mandatory by 70 1/2.

Taxes:
A Roth IRA earnings and principal are 100% tax-free when rules and regulations attached to them are followed. (You pay taxes on the principal before putting it into your IRA).
With a traditional IRA, taxes are paid on earnings when withdrawn from the IRA.

Use of funds:
With both a traditional and Roth IRA, funds can be used to purchase a variety of investments. The money can be invested in stocks, bonds, mutual funds, certificates of deposit and more, and the earnings from these investments are taxed the way any other money in the IRA is taxed.

Who can have an IRA:
A Roth IRA is only available to single-filers who make less than $95,000 a year, or $150,000 if filing jointly.
A traditional IRA is available to everyone with no income restrictions.

Penalties:
With a Roth IRA principal contributions can be withdrawn at any time without penalty.
With a traditional IRA, all funds withdrawn before 59 1/2 are subject to a 10% penalty, even your principal.

While there are clearly differences between the traditional and Roth IRA, the biggest difference is the way they are taxed. For example, a Roth IRA is 100% tax-free when you start making withdrawals. You pay taxes on the money before you invest it into an IRA. A traditional IRA gets taxed on the income you withdraw, and can any contribution can be used as a deduction from your taxable income. So, if you make $50,000 a year, and contribute $2200, you can only be taxed on $47,800. Thus, it is a good way to lower your taxable income, but will cost you when you retire because you pay deferred taxes. Thus, when possible (in other words, if you qualify with the income restrictions), a Roth IRA is the better of the two, as earnings are tax free. This means if your Roth IRA investments go well, you could retire in style without paying a hefty tax on it as income when you no longer have things like home mortgage interest, etc. to offset your income and use as a deduction.