Traditional or Roth IRA: Which Should You Open?
When you open a retirement account, you can choose a Traditional or Roth IRA. These accounts offer some of the same benefits, but the details differ.
How They're Alike
Traditional and Roth IRAs are retirement vehicles that come with tax incentives to help you save money. With each, the money you've invested grows tax-free until you reach retirement age. Both types are subject to penalties if you withdraw funds before the age of 59½.
There's also a limit on the total amount you can contribute in one year. In 2017, the maximum you can contribute across all IRAs is $5,500 (or $6,500 for those 50 and older), according to the IRS.
When You Pay Taxes
Although you won't pay taxes on either a Traditional or Roth IRA account while your investments grow, you will have to pay taxes either when putting money in or taking money out.
Contributions to your Traditional IRA may be tax deductible. This means you won't pay taxes on the money you initially deposit. However, your withdrawals will be taxed at the applicable federal and state income tax rate. By choosing a Traditional IRA, you may be able to lower your taxable income to a lower threshold, thereby making you eligible for more tax breaks, such as an increased child tax benefit.
With a Roth IRA, you pay income taxes on money you deposit into your account. But when you withdraw money during retirement, you don't owe taxes on it. As the point of an IRA is to grow your wealth, the amount you withdraw will likely be significantly higher than the amount you contribute. Therefore, you'll have less overall taxable income during your lifetime.
In other words, a Traditional IRA can postpone the taxes on your contributions, and a Roth IRA lets you pay taxes now rather than later in life.
In order to contribute to a Roth IRA, your income needs to be below a certain limit, which depends on your tax filing status. If you or your spouse has a retirement plan through a job, you might not be able to deduct a Traditional IRA contribution, or you could be eligible only for a partial deduction. This depends on how much income you have.
Taking Out Your Money in Retirement
The best retirement account for you depends on the details of your finances. If you expect to be in a lower tax bracket during retirement, you may prefer the Traditional IRA because you can defer taxes until you retire. On the other hand, if you expect to have new income streams and higher taxes when you're older, you might benefit from a Roth IRA, which lets you pay taxes on your contributions now.
Also consider that you must stop contributing to a Traditional IRA and start withdrawing money once you reach the age limit. Starting at age 70½, you have to start taking required minimum amounts out of your Traditional IRA each year, according to the IRS. But you can continue to leave funds in a Roth IRA past that age. There's no requirement to withdraw.
If you plan to continue working past the standard retirement age, a Roth IRA might be a better choice. But if you intend to retire in your 60s, a Traditional IRA might more suitable.
No matter which account you choose, it's important that you do choose and start putting money away. Saving for retirement can be complicated, but it's worthwhile to take the steps and invest in your future.