Roth IRA vs. Traditional IRA: What You Need To Know

No matter what stage you are in life, it is never too soon to start saving for retirement. Even if you are already invested in an employee-sponsored plan, it is not your only retirement account option.

An individual retirement account (IRA) allows you to save for retirement with tax-free growth or on a tax-deferred basis. There are different types of IRAs with different rules and advantages. Roth IRA and traditional IRA are the most popular types.

With a Roth IRA, you pay taxes upfront by contributing your after-tax dollars and later in retirement withdrawing tax-free funds.

However, with a traditional IRA, you contribute your pre-tax dollars, delaying tax payments until you withdraw funds from your account in retirement.

In addition to the above conditions, there are some situations where you might be exempt from paying the 10% penalty from both IRAs. If the money is taken out for: qualified first time home buyer expenses(up to $10,000), higher education expenses, permanent disabilities, death, long-term unemployment expenses and certain level of medical expenses. You will, however, still need to pay taxes.

Table comparing & contrasting the differences between Roth & Traditional IRAs

Roth IRA or Traditional IRA?

A Roth IRA can be a better option if:

  • You expect a higher income in retirement than what you earn now
  •  You want the flexibility to withdraw your contributions

A traditional IRA is a better option if:

  • You expect a lower income and tax rate in retirement

The Takeaway

The truth is, whichever account you choose will set a path for retirement. Understanding your options and the advantages and disadvantages can help you select and set up your choice of retirement account. The most important thing is actually getting started.

Compound interest is powerful.

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