Individual Retirement Accounts (IRAs) are retirement savings accounts that provide tax advantages on your contributions. Several types of IRA accounts exist, offering different tax advantages. However, the two common IRA accounts are the Traditional IRA and Roth IRA.
Knowing the differences between the two IRA accounts can help you make an informed decision for your retirement savings. Here is what you need to know about the traditional IRA vs. Roth IRA.
Differences in Definition
The traditional IRA account has tax-deductible contributions and taxed distributions. Your monthly payments to the account do not receive any taxation. However, once you retire, your withdrawals get taxed as income using the prevailing income tax rate.
On the other hand, contributions in a Roth IRA account get taxed, but the distributions and earnings after retirement are tax exempted. You use after-tax dollars to contribute to your Roth IRA account. If you invest this money or wait until you retire to access it, your investment gains and withdrawals get tax-exempted.
The IRS sets the eligibility rules for all IRA accounts. The rules determine whether you save in a traditional or Roth account. For instance, your income determines if you are eligible for a Roth account.
Variations in Contributions
The IRA decides the maximum tax-free income you can contribute to your traditional IRA and Roth IRA account. The maximum contribution amount should not exceed $6,500 in 2023 or $7,500 if you are older than 50.
There is contribution eligibility for Roth IRA account holders. The income of these account holders should not exceed a specified income level. The traditional IRA account has no restrictions.
Anyone with earned income is eligible to own this account. There are no age restrictions to start making contributions for both accounts. You can start making contributions as soon as you earn your first income.
Withdrawal Variations in Traditional IRA vs. Roth IRA
There are no mandatory distributions on the Roth IRA account. You can start collecting your distributions at any moment with the Roth IRA account. The withdrawals do not incur penalties and remain tax-free after five years of saving.
Furthermore, the ability to contribute gets phased out at higher income. Contributions in the Roth account grow tax-free. However, there are no other tax benefits because the money is tax-exempt.
On the other hand, in traditional IRA accounts, contributions grow tax-deferred. You enjoy immediate tax benefits. However, the tax advantages are subject to income limitations for account holders in employer-sponsored plans. The contributions can also be phased out depending on income.
Withdrawals in a traditional account start getting taxed when the account holder reaches 59½ years of age. Mandatory distributions begin at age 73. Distributions made before the account holder attains 59½ years incur a 10% penalty.
The Roth IRA account is practical for someone expecting to be in a higher tax bracket after retirement. They get to enjoy tax-free distributions from their investments and ordinary withdrawals. The traditional IRA account is for someone who will maintain their current tax bracket or move to a lower tax bracket after retirement.
Choose the Most Suitable Account For You
The taxation rate is the crux of the matter in a traditional IRA vs. a Roth IRA. Nobody can predict with utmost certainty future tax rates. You can use the services of a financial expert to determine which account is suitable for you.