If you think a Roth IRA and a Traditional IRA sound similar – that’s because they are. However, there are some important differences between them. Below, we will compare a Roth vs Traditional IRA so you can choose which is right for you!
Roth vs Traditional IRA – 5 Similarities
- They are both investment accounts. When you hear of someone “investing in an IRA,” they mean that they are investing in things that they hold in their IRA. An IRA is just a holding area for investments that you choose.
Imagine an IRA like a house. If you put the right renovations into it, the value will increase. - Many people don’t know that non-working spouses and minors can contribute to both of these IRAs – as long as they meet certain requirements. These are often referred to as “Spousal Roth/Traditional IRAs” and “Custodian Roth/Traditional IRAs.”
- The deadline to make contributions to an IRA is April 15th (Tax Deadline Day.) That means that you have more than a year to make an annual contribution. For example, let’s say you wanted to make more of a contribution in 2019 but it is now January 2020. You actually have until April 15, 2020 to make a contribution and have it count for the following year. So your 2019 contribution dates would be from January 1, 2019, to April 15, 2020.
- 59 ½ is the magic number to remember. You can take distributions from your IRA penalty-free after you turn 59 ½.
- Maximum contributions can vary depending on how much earned income you make and what type of marital status you claim. Currently, you cannot contribute more than $6,000 if you are younger than 50. If you are older than 50, the maximum amount you can contribute is $7,000.
Roth vs Traditional IRA – Differences
Tax advantages:
You are probably going to discover how to choose between a Roth IRA and a Traditional IRA by understanding the tax differences between them. Out of all the differences, this is the difference that people pay the most attention to.
A Roth IRA usually does not allow you to deduct any contribution amount from your taxes. However, when you want to start taking distributions in the future (distributions = take money out of it,) the money can be pulled out tax-free. You won’t be taxed on any earnings from your investments.
A Traditional IRA usually does allow you a tax deduction on what you contribute. Although you should know that in the future, you will pay tax on your contributions and earnings when you withdraw.
As with all things related to money and the IRS, everything has exceptions. You have to meet certain guidelines to be able to deduct all or some of your Traditional IRA contributions.
Age limit for Contributions:
*Update*
Here is some great news! I was recently informed by an awesome reader that as of 2020, there is no age limit for making regular contributions to traditional or Roth IRAs.
In 2019, if you were 70 1/2 or older, you couldn’t make regular contributions to a traditional IRA.
You can always check the IRS’s IRA page here for the latest contribution updates.
Penalties:
One of the greatest advantages to a Roth IRA is that you can withdraw any money you contribute at any time without a penalty. If you need to withdraw money from your earnings though, you will pay a 10% penalty if you are younger than 59 ½.
For example (Under 59 ½): Let’s say you contributed 5,000 dollars to your IRA. And let’s say that the money you invested made you an additional 1,000. So you now have $6,000 in your account. Now, imagine that you had an emergency and needed money. You could withdraw your $5,000 without penalty. However, if you needed the extra thousand that your investments earned, you would pay a 10% penalty ($100.)
For Traditional IRAs, you will be penalized 10% on all withdraws you make before you are 59 ½, regardless if you personally contributed the money or not.
Again, there are exceptions that you can use to your advantage to avoid paying the penalty. You should always seek a professional before making a financial decision – they might be able to help you find an “exception” that will work in your favor.
There are no penalties for withdrawing funds after age 59 ½.
Required Distributions:
There are no time requirements for when you need to start taking money out of your Roth IRA.
For a Traditional IRA though, you are required to start taking distributions by the next April 1st -after you turn 70 ½ years old.
Conclusion:
In most cases, people usually prefer the Roth IRA over the Traditional IRA for two reasons. First, in an emergency, you can access all the money you contributed without paying a penalty. And second, you don’t have to pay taxes on the money you earn.
Planning for retirement is one of the most important decisions you make in life. Now that you can compare a Roth vs Traditional IRA, you can choose which is right for you. If you have further questions, you should seek a professional to help you determine which investment account to start with.
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