Roth IRA vs Traditional IRA: What You Need to Know

Do you know the difference between a Roth IRA and a Traditional IRA? Maybe you’re looking into getting one, but aren’t sure which is right for you. Perhaps you already have one or the other, but want to fill in some gaps in your knowledge. For example, did you know you must begin withdrawing when you turn 70 ½ if you have a traditional IRA?

Planning your financial future can be intimidating. However, it’s a very necessary and crucial step towards becoming worry-free and financially stable. If you’re among the many who are stumped about their retirement plans, let Alert1 give you some advice on your IRA.

IRA stands for ‘Individual Retirement Account’. They are used to save money for your retirement. IRAs are types of savings accounts that come with tax breaks.  There are two different kinds of IRAs will discuss today: Roth and Traditional.

IRAs are often confused with 401ks. The IRA is a private retirement plan you set up yourself; 401ks are provided by your employer. 

The Roth IRA and Traditional IRA both have their own unique benefits.

Roth IRA

• You pay taxes on your contributions at the time you make the contribution.
  
• You can withdraw your contributions at any time. However, you can only withdraw your principal contributions, you cannot withdraw any gains.
  

For example, let’s say you’ve had your Roth IRA for 2 years. Each year you contributed $1,000. Then you have a 5% gain of $100, and your account now has $2,100.

You now decide to withdraw. You’re entitled to withdraw only $2,000 – this is your principal contribution. You will not be able to withdraw the $100 gain.

• All withdrawals are tax-free.
  
• You are not required to make any required minimum distributions (RMDs) when you turn 70 ½ years old. An RMD is a required amount that you must withdraw each year.
  
• If you are 49 years and under, the contribution limit is $5,500 per year.
  
• If you are 50 years and older, the contribution limit is $6,500 per year.

Traditional IRA

• Contributions are tax deferred, meaning you pay taxes when you withdraw your contribution.
  
• If you withdraw before the age of 59 ½ years old, you will be penalized. There is a fee of 10% of the withdrawal amount.
• When you turn 70 ½ years old, you must withdraw an RMD based on size of your IRA and begin paying taxes.
  
• Like Roth IRAs, if you are 49 years and under, the contribution limit is $5500 per year.
  
• Also the same as Roth, if you are 50 years and older, you can contribute up to $6500 per year. 

Some people will prefer a Roth IRA over a Traditional IRA, and vice versa. Others may prefer to have both types of IRAs. If you’re not sure what kind of IRA is right for you, we have some recommendations to help narrow down your choice.  

Income Tax Bracket

The first important thing to consider is which income bracket you’ll be in in the future. If you believe you’re likely to be in a lower income bracket in the future, a Traditional IRA is for you. This is because with a Traditional IRA, you’ll only pay taxes at the time of withdrawal. If you’re in a lower income bracket at the time of withdrawal, you’ll pay a smaller amount in taxes.

If you believe you’re likely to be in a higher income bracket in the future, a Roth IRA will be more beneficial for you. This is because you’ve already paid your taxes when you made your contributions. Let’s say you’re in a higher income bracket in the future with a Traditional IRA. The result is you’d be paying a much heavier amount in taxes during withdrawals.

Withdrawal Flexibility

Another important thing to consider is withdrawal flexibility. If you’ll need flexibility for withdrawals, you’ll want to choose a Roth IRA. The Roth IRA does not penalize you for withdrawals and you can withdraw at any time. With a Traditional IRA, you can’t make withdrawals until the age of 59 ½ without being penalized.

Income limits

With a Roth IRA, there are income limits. If you exceed these income limits, your only option will be a Traditional IRA. For single contributors, the income limit is $117,000 per year. For married contributors, the joint income limit is $184,000.

A tip for you:

The contribution limits for both the Roth and Traditional IRA per year are equal ($5500 for 49 year olds, $6500 for 50+ year olds). Your contributions will depend on what you’re able to contribute according to your financial status. However, it’s recommended to contribute the maximum amount each year. The more you contribute, the more gains you have that are tax-protected.

Now, you have a better insight on your individual retirement plan. Whether you’re in your 20s or your 50s, understanding your retirement plan options is always important. Here at Alert1, we highly recommend that you take control of your financial future today. 1 in 3 Americans have $0 saved for retirement. Don’t contribute to this statistic – instead, contribute to your IRA!

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