A traditional IRA and a Roth IRA are two defined-contribution plans with significant — but quite different — tax advantages that can help you save for retirement. Depending on factors like where you are in your career or whether you see any big-ticket expenditures in your future, you may find that one is better for you than the other, or that investing in both makes the most sense for your retirement planning.
A traditional IRA is an investment option for anyone under 70½ years old. It allows you to invest pre-tax income into your retirement plan and defer taxes on your earnings until you make a withdrawal. In a nutshell, you get the tax breaks now, but will ultimately pay those taxes at the other end of the line, when you’re ready to withdraw your retirement funds. You will be taxed at whatever tax bracket you’re in when you withdraw the funds, so if you know that your tax rate will be lower in retirement, a traditional IRA can provide you with a tax break now and still not burden you with heavy taxes when you retire. However, if you are in a high tax bracket when you withdraw funds, you will have to pay that rate upon distribution.
Funds contributed to a Roth IRA, on the other hand, are not tax-deductible. In other words, you pay the taxes before contribution, but there are no taxes or penalties when you make a withdrawal that is a qualified distribution. This makes a Roth IRA an excellent investment option for people who may still need to access their money for other life goals. By putting your funds into a Roth IRA, you get the benefits of compounding interest, so your money generally grows faster than if you had simply put it into a savings account. And it’s there for you when you need it — you can withdraw what you’ve put in (although not what you’ve earned), tax and penalty free, for whatever expense comes up. A Roth IRA is also an excellent option for people who are in a lower tax bracket now, or who expect their tax rate to be higher in retirement. And unlike a traditional IRA, there is no age limit on a Roth IRA, so you can invest in your retirement for as many years as you want, as long as you meet the other eligibility requirements.
This information is not intended to be a substitute for specific individualized tax, legal, or investment planning advice. Please consult a tax professional for details.