Retirement accounts can be tricky to figure out. There are a lot of different retirement accounts that you can choose from -- yet, most people couldn't begin to tell you the difference between them. However, knowing how they are different is vital to choosing an account that suits your needs best. For example, IRAs are very popular, but there are several different types, including traditional IRAs and Roth IRAs. The following is a brief rundown of Roth vs. a traditional IRA to give you a better idea of which might work better for you.
Roth vs. Traditional IRA
Before figuring out what the difference between a Roth IRA and a traditional IRA is, it helps to know what an IRA is. AN IRA (individual retirement account) is an account that lets you save for retirement with either tax-free growth or on a tax-deferred basis. With that in mind, the following are the differences between the two:
When you use a traditional IRA, you can contribute money from your income to your account without having taxes taken from it right away. Instead, the taxes you pay on the income you've contributed to your traditional IRA will be delayed until you withdraw that money in retirement. The problem lies in the possibility that once you do withdraw money from your IRA, the tax rates could be higher than they were before.
Think of taxes like a farmer might. Do you want to pay taxes on the seed, and enjoy the harvest tax free? Or do you want to defer taxes, and pay taxes later on after harvest? The tricky part is that we know what taxes are today, but we have no way to know what taxes will be after the harvest. When it comes to Roth IRAs, taxes will come out of the money you contribute to the account right away, which means that you won't be taxed on any of the money you withdraw in retirement.
The contribution limits are the same for both traditional and Roth IRAs. For 2019, the contribution limit was $6,000 for individuals under the age of 50 and $7,000 for individuals over 50. That number will stay the same in 2020.
Your income won't limit how much you can contribute to a traditional IRA; however, this is not the case for a Roth IRA. Although there are income limits on a Roth IRA, they are quite high. For example, in 2019, you could only make a $6,000 contribution (the contribution limit), if you made less than $122,000. If you made more than that, you could only make a partial contribution. If you made more than $137,000, then you wouldn't be eligible.
You can no longer make contributions to your traditional IRA once you turn 70 1/2 years old, but unlike a traditional IRA, there are no age limits on the contributions you can make to a Roth IRA.
One of the biggest differences between a Roth IRA and a traditional IRA is the required minimum distributions. Once you turn 70 1/2 years old, you will be forced to begin taking distributions if you have a traditional IRA. If you have a Roth IRA, then you won't be forced to take distributions at any age.
If you have a Roth IRA, then you can withdraw money from your account at any time. You've already paid tax on it, which means it won't be taxed again. Additionally, there are no fees for withdrawing funds from the account. With a traditional IRA, you will have to pay taxes on any money you take out and if you withdraw money before you're 59 1/2 years old, you will have to pay an additional penalty.
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