Understanding IRA Accounts:The Difference Between Traditional and Roth IRAs
Published July 12, 2019
At first glance, an Individual Retirement Account (IRA) might seem like a fancy name for a regular savings account. But in reality, an IRA is a very powerful tool that can help you save for retirement.
This is the first part of a series that will go over what you need to know about IRAs so you can be ready to make your future, retired-self very happy.
What exactly is an IRA?
In short, an IRA is an investment account that is designed to aid in building your retirement savings. While there are several different types of IRAs, we are only going to talk about the two most common: traditional IRAs and Roth IRAs.
But before we get into more detail, it’s important to go over how an IRA works.
Understanding the account
With both a traditional and Roth IRA, you are able to contribute $6,000 per year ($7,000 if you’re over 50), even if you’re contributing to a 401(k) or another workplace retirement plan. These IRA contribution limits are up from $5,500 and $6,500 in 2018.
For a traditional IRA, you won’t owe income taxes on the money until you withdraw the funds. Alternatively, with a Roth, your contributions are not tax-deductible. Meaning you pay taxes when you contribute the money. However, the money will grow tax-free and you can also withdraw the money tax-free in retirement with a Roth IRA.
The difference between a Roth IRA and Traditional IRA
Traditional IRA: Generally, you can deduct the amount of your contributions on your tax return, and your money grows tax-deferred. That means that you won’t owe taxes until you withdraw the money from the account.
Anyone, regardless of income, can contribute to a traditional IRA. However, if you or your partner have access to a retirement plan at your job you may be limited in the contribution amount available to be deducted on your taxes.
Roth IRA: If you want to wait to get your tax break, the Roth can be an attractive option.
With a Roth, you must pay taxes on your contributions now, but your money will grow tax-free. You will not owe any taxes on the gains in your account, and you can withdraw the money tax-free in retirement.
While you can’t deduct Roth contributions from your taxable income while saving, in retirement your Roth withdrawals are not taxed at all. That goes for contributions and investment earnings. That is different from a traditional IRA where you pay taxes on both your contributions and earnings when you withdraw money.
In our next part, we are going to go over the rules of withdrawing money from your IRAs, so make sure to stay tuned our Explore page so you don’t miss it!