Traditional vs. Roth IRA: Which One is Right For You?

Traditional vs. Roth IRA: Which One is Right For You? Featured Image
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IRAs, or Individual Retirement Accounts, are a great way to help you save money for the retirement you’ve been dreaming about. An IRA is like a savings account, but you can’t touch your money until you reach a certain age without penalties. They typically have a higher interest rate than savings accounts to help you save more over time.

Did you know there are different kinds of IRAs to choose from? Depending on your personal situation, a Roth IRA or a Traditional IRA might be better for you. Here we’ve compared and contrasted the two types of IRAs so you can better decide which one is the right one for you.

Traditional IRAs

A traditional IRA lets you contribute pre-tax income that earns interest over time. You don’t pay taxes on a traditional IRA until you make withdrawals in retirement. And depending on your eligibility, you may be able to deduct your contributions from your tax return.

Anyone under the age of 70 ½ can invest in a traditional IRA, so long as you have taxable income. If you are under 50 years old, you can contribute up to $5,500 a year. If you’re 50 years or older, you can contribute up to $6,500 a year. At 59 ½, you can start withdrawing funds penalty-free.

If you do need to withdraw your funds early, you can do so without penalty if it is for a first-time home purchase, health or disability emergency, or qualified education expenses. Otherwise, you’ll have to pay a 10% federal penalty tax on both contributions and earnings that are withdrawn.

Also, on April 1 of the year after you reach 70 ½, you must take a required minimum distribution from your traditional IRA, and you’ll have to take this minimum distribution each year by December 31st.

Roth IRAs

A Roth IRA lets you contribute after-tax income that also earns interest over time. With this kind of IRA, you pay taxes on your money from the beginning, and can take your money out tax-free when you withdraw in retirement. Roth IRAs also have income limits.

Anyone with taxable income can contribute to a Roth IRA, regardless of age. But, similar to the traditional IRA, if you are under 50 years old, you can contribute up to $5,500 a year, and $6,500 if you’re 50 years or older. You can start withdrawing funds penalty-free at age 59 ½.

If you need to take money out of your Roth IRA early, there is no penalty if the funds have been in the account for at least 5 years, AND you are using the money for a first-time home purchase, a health or disability emergency, or qualified education expenses.

You can withdraw your contribution without penalty, but there is a 10% federal penalty tax on earnings withdrawals.

There are no required minimum distributions with Roth IRAs. You can take what you want, when you want, without penalty when you reach age 59 ½.

What’s the difference?

So what’s the real difference? It’s when you pay taxes. Traditional IRAs pay taxes when you take it out, and Roth IRAs pay taxes when you put it in. There some other differences, as you’ve seen, but when it comes to deciding which IRA to get when you pay taxes is often the biggest deciding factor.

So which one is right for me?

This depends on a couple of things. If you like the idea of being able to deduct your IRA on your taxes, a traditional IRA might be right for you. Just remember that you have to pay taxes when you take the money out.  

But if you like the idea of being able to withdraw your contributions anytime you want without penalty, and withdraw funds tax-free when you reach 59 ½, then a Roth IRA might be better for you. Just don’t forget that you’ll have to pay taxes on your contributions.

Whichever you pick, both IRAs will help you save significantly for the future. If you still need help deciding which is best for you or to set up your account, visit one of our branches or call us at 1-800-321-DIME (3463).

Sources: Vanguard

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