Traditional or Roth, which one is right for you? Both can help you save for retirement but offer different advantages. Selecting an IRA is a big decision with potentially big financial consequences. So it's important to know how the two types of IRAs differ to understand which one works best for you.
Attributes of a Traditional IRA
- Annual tax-deductible contributions1
- Earnings grow tax-deferred2
- Taxes paid on account earnings upon withdrawal
- No income cap and open to everyone under age 70½ with earned income. Annual contribution may not exceed total earned income.
- Withdrawal of funds before 59½ is subject to a 10% penalty
- Mandatory distributions by 70½
Attributes of a Roth IRA
- Account funded with after-tax income
- Tax-free growth and tax-free withdrawals3
- Principal can be withdrawn at any time without penalty
- Earnings are federally tax-free after a five-year aging requirement as long as one of several conditions is met, including age 59½, disability, or qualified first-time home purchase.
- Generally only open to single filers with income up to $125,000 or married couples with a combined income of up to $183,000 annually (in 2012)
- No mandatory distributions in your lifetime
Tax-deferred vs. Tax-free
The main difference between a Traditional and Roth IRA is the way they are taxed. With a Traditional IRA, there is an up-front tax benefit since all or part of your annual contributions may be tax-deductible subject to income requirements. Your account grows tax-deferred, but you’ll pay taxes later on. A Roth IRA grows tax-free because you’re taxed on your contributions up front. You’ll also have the benefit of tax-free withdrawals with no required distributions.
Both IRA types offer tax benefits. What works best for you depends on your income level and financial situation. Consult your financial advisor about which one may be right for you.