If you are shopping for a retirement savings account, you’re likely to encounter many options, including various types of individual retirement accounts. Although a traditional IRA and a Roth IRA both offer tax advantages as you save for retirement, they have a number of differences that you’ll want to keep in mind.
The primary difference between a traditional IRA and a Roth IRA concerns how the government taxes your nest egg. Contributions to a traditional IRA are tax-deductible up to an annual limit set by the IRS. Contributions to a Roth IRA are not tax-deductible. Your Roth IRA makes investments and grows your money just as a traditional IRA, but you can withdraw contributions from the account without incurring any additional taxes. In short, a traditional IRA requires that you pay taxes on your retirement funds when withdrawing money, and a Roth IRA requires that you pay taxes on the funds before contributing them.
If you have a traditional IRA, according to CNN Money, the U.S. government requires that you begin taking withdrawals from your retirement account once you reach age 70 1/2. If you have a Roth IRA, you are not subject to mandatory distributions; instead, you may leave funds in your retirement account as long as you like, even passing them on to your heirs. Similarly, you may continue to make contributions to a Roth IRA as long as you wish. Traditional IRAs do not allow contributions after you reach age 70 1/2.
Aside from taxation at the time of distribution, there are few limits to a traditional IRA. If you have a high salary, though, you may be subject to certain limitations under a Roth IRA plan. Roth IRAs are only available to single tax filers making less than $127,000 per year as of 2013, and single filers with taxable income greater than $112,000 are subject to certain additional limitations. If you are married and have an adjusted gross income of more than $188,000 per year as of 2013, you cannot qualify for a Roth IRA; similarly, you may be subject to additional limitations if your AGI is higher than $178,000. Regardless of the type of IRA you have, you may only contribute the lesser of $5,500 per year or your total compensation as of 2013.
Under both traditional and Roth IRAs, your funds can grow tax-free while invested. Because you have already paid taxes on your contributions to a Roth IRA, you may withdraw them at any time without penalty. In most cases, however, if you withdraw funds from a traditional IRA before you reach age 59 1/2, you will pay your standard tax rate plus an early distribution penalty of 10 percent.