With a Roth IRA, you deposit dollars after tax, your money grows tax-free, and you can usually make tax-free and penalty-free withdrawals after 59½ years. With a traditional IRA, you deposit dollars before or after taxes, your money grows tax-wise, and withdrawals are made after 59. Age of 18 taxed as current income. The main difference between a Roth IRA and a traditional IRA is how and when you get a tax break. Contributions to traditional IRAs are tax deductible, but retired withdrawals are taxable.
In comparison, contributions to Roth IRAs are not tax deductible, but retirement withdrawals are tax-free. Let’s say you’re eligible for both a Roth and a traditional IRA. In general, you’re better off in a traditional business if you expect to be in a lower tax bracket when you retire. By deducting your contributions now, you’ll lower your current tax bill.
When you retire and start withdrawing money, you’re in a lower tax bracket, meaning less money is available to the tax authority overall. If you expect to be in the same or higher tax bracket in retirement, consider contributing to a Roth IRA instead so you can pay your tax bill now, not later. A traditional IRA is your only option if you don’t qualify for a Roth IRA due to income restrictions. In contrast, you can withdraw amounts equal to your Roth IRA contributions at any time and for any reason, free of penalty and tax, even before 59. year of age.
Beneficiaries of Roth IRAs also do not owe income tax on withdrawals, but must make distributions or deposit the account into their own IRA. An important aspect of deciding between a traditional IRA and a Roth IRA is what you think your future income (and therefore your income tax bracket) will look like compared to your current situation. There are no required minimum distributions (RMDs) for Roth IRAs, which means you don’t have to withdraw money at any age or to your life. If income limits make direct Roth IRA contributions impossible, you can always opt for a Roth IRA conversion through the back door.
Aside from the differences outlined above, traditional IRAs and Roth IRAs share a number of common characteristics. The general thought is that if you expect your taxes to be higher in the future, you opt for the Roth IRA, and if you think taxes will be lower, contribute to a traditional IRA and save on taxes today while hopefully being in a lower tax bracket later. Different rules apply when you withdraw income (amounts that exceed the amount you deposited) from your Roth IRA. As long as your MAGI is below the annual limit and you receive a taxable allowance that equals or exceeds your contribution, you can contribute to a Roth IRA.
On the other hand, if you meet the requirements for a Roth IRA, it may make sense to prefer that account over a traditional IRA. If your tax rate is lower now than when you started the payout, you can maximize your tax benefits by making a Roth IRA contribution this tax year and receiving tax-free withdrawals in the future, provided you’ve met eligibility requirements. If you want to invest in a Roth IRA but don’t meet the income requirements, you can still take advantage of the tax-free growth and subsequent distributions through a Roth conversion through the back door. For example, if you’ve already signed up for a tax-deferred 401 (k) plan through your employer, you might want to invest in a Roth IRA if you’re eligible.
But at some point, you’ll have to face that tax burden in retirement, which means you can hardly go wrong with a Roth IRA unless you need that tax break upfront.
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