Traditional IRAs vs Roth IRAs
If you’re just starting to think about planning for retirement, you’ve probably heard a lot about IRAs, or Individual Retirement Accounts. People tend to talk about two kinds of IRAs– the traditional and the Roth IRA. While these two accounts might seem similar, they have some key differences that can make a big difference in saving for retirement.
- The biggest difference between a Roth and a traditional IRA is when you are required to pay taxes on the money going into and out of the account. Traditional IRAs are funded with pre-tax money, meaning you can deduct any contributions from your taxed income for the year. However, you’ll owe taxes when you make withdrawals in retirement. Roth IRAs, on the other hand, are funded with money that you’ve already paid taxes on, so you won’t owe any additional taxes when you make withdrawals. In short– funding a traditional IRA can help you reduce your current taxable income while funding a Roth IRA can help you reduce your future tax bill.
- One of the other big differences between Roth IRAs and traditional IRAs is whether you’ll have to take RMDs (required minimum distributions). When dealing with a traditional IRA, you’ll have to begin making yearly withdrawals from your account after you turn a certain age (as of 2023, you’ll have to start taking RMDs the year you turn 73). With a Roth, you’ll never be required to take money out of the account and won’t have any RMD’s, which means you could pass on a potentially much larger sum to your beneficiaries. If you do take distributions, you get to choose when and how much, allowing you far more flexibility in planning for income in retirement.
- The final thing to keep in mind when deciding between a traditional and Roth IRA is when you’re allowed to withdraw money from your account, so you know when you’ll be able to access your money penalty-free. For both traditional and Roth IRA’s, you can withdraw your money with no early-withdrawal penalty after age 59 ½. In a traditional IRA, any withdrawals before reaching that age will likely be subject to a 10% penalty fee. With a Roth IRA, you can withdraw your contributions at any point, penalty-free. However, you won’t be able to withdraw your earnings without paying the 10% penalty. Exceptions do apply, so it’s always a good idea to check with your accountant or tax preparer before accessing funds.
- For both accounts, there are some opportunities to make early withdrawals, like for first-time home purchases or for qualified educational expenses.
So, which account is right for me?
It depends! There are tons of factors that contribute to which account would make more sense for you and your unique situation. Future and current income level is probably one of the most important things to consider, but everybody’s financial picture looks a little bit different. If you’re still having trouble deciding, consider talking to a qualified CFP™ at Harbor Wealth Management to get started with a custom-tailored financial plan and feel confident in your choice.