Traditional and Roth IRAs help you save for retirement in opposite ways. With a traditional IRA, your contributions are tax-free but you pay income tax when you withdraw money years later. With a Roth, there's no tax-deduction for contributions but everything you take out later, contributions and earnings alike, is tax-exempt.
Paying Tax Later
When you choose between a Roth and a traditional IRA, you're making assumptions about the future. The theory behind a traditional IRA is that when you're young, you're in your peak earning years and your income in requirement will be less. By paying less tax now, when your income puts you in a higher tax bracket, then paying tax on withdrawals when you're in a lower one, you come out ahead both now and in the future.
Paying Tax Now
If you anticipate paying as much or more income tax in later years as you do now, a Roth makes more sense. For example, if you're just starting your career, your income will hopefully go up as you become more successful. By the time you reach retirement you could be richer and also require more money to maintain your standard of living. In those cases, paying tax on income now, while you're in a low bracket, is advantageous.
If you withdraw money from a traditional IRA before you turn 59 1/2, you pay income tax on the withdrawal, plus a 10 percent penalty. There are exceptions, such as when you need to pay major medical bills. When you turn 70 1/2, annual withdrawals are mandatory: the IRS bases the amount you have to take out on your projected life expectancy. You can take out more than the minimum one year, but you still have to make a new minimum withdrawal the next year.
Once your Roth has been open five years, you can take out your original contributions at any time, with no tax penalty. If you withdraw earnings before 59 1/2, you pay a 10 percent tax penalty, but your earnings aren't subject to regular income tax. You never have to make a mandatory minimum withdrawal from a Roth -- in fact, you can go through life without ever touching it and leave the money for your children to inherit.
A graduate of Oberlin College, Fraser Sherman began writing in 1981. Since then he's researched and written newspaper and magazine stories on city government, court cases, business, real estate and finance, the uses of new technologies and film history. Sherman has worked for more than a decade as a newspaper reporter, and his magazine articles have been published in "Newsweek," "Air & Space," "Backpacker" and "Boys' Life." Sherman is also the author of three film reference books, with a fourth currently under way.