ROTH vs Traditional IRAs

Ah, the wonderful world of Individual Retirement Accounts (or IRAs in money-speak).  So riveting. So in demand.  Why, I'll bet that you were just saying to yourself: "I simply have to have more info on these IRAs!" Well, my friend, today is your lucky day.  We are going to plunder the depths of not only a traditional IRA, but also its cousin, the Roth IRA, and will bring to light all the differences they thought they could keep buried. Here we go!

"Aren't you being a tad melodramatic," you might say. "I mean, we are talking about just accounts, here."

Just accounts?  Let me put it this way:  do you want to retire someday?  Punch that time clock one last time and never look back?  Of course you do!  But, you are going to need something to live on as you move on to your golden years.  This is where an IRA comes in very handy.  Starting now, you can put money in your IRA and watch it grow.  Plus, there are some nifty tax advantages you get just for using one of these accounts.

Oh, tax advantages?

Uh huh, I have your attention now, don't I?  Yep, these nifty accounts not only let your money safely multiply (hopefully like Star Trek's Tribbles) over time, they also let you off the hook on taxes, too.  Well, sort of.  Here's probably where the biggest difference between the two comes in to play. 

Traditional IRA Benefits

Your traditional IRA will let you deduct the amount of your annual contribution from your taxes.  If you make $15,000 slinging burgers at BK and manage to sock away $1000 of it into your IRA, you are really only going to be paying taxes this year on $14,000.  Plus, that money you put in will continue to grow, tax free. On the other hand, contributions to a Roth IRA will not be tax deductible, so you'd still pay taxes on the full $15,000.

But it should be noted that the traditional IRA doesn't let you off of the tax hook forever. Sure, you'll get the deduction today, but when it comes time to get your money, that's when you get to write a big, fat tax check to the beloved IRS. This is assuming, too, that you're waiting until you hit 59 1/2 in age to start withdrawing money. If you get trigger happy and decide to pull some money out before that age, chances are you'll end up owing a 10% penalty. Some exceptions to the penalty here are: if you're taking out money for higher education costs, buying a home for the first time, paying off some huge medical bills (if the expenses exceed a certain percentage of your income), and if you become disabled.

So what does a Roth IRA do for me?

Well, you might not be able to see any deductions from your taxes now. But, keep your money in the Roth IRA for at least five years and reach the magic age of 59 1/2, and you'll be able to withdraw your money and its lovely earnings without paying taxes!  You read that right.  Follow the rules, and you'll walk off with your expanded amount without having to pay taxes. 

Bear in mind, though, that if you should take out money before five years is up or before hitting the big 5-9 and 1/2, you will have to pay Uncle Sam.  Like anything in life, there are some exceptions to this rule.  If you're looking to buy your first home and have had money in your Roth IRA for at least five years, you can take out $10,000 tax free.  Also, there are some educational expenses that give you a magic ticket to withdrawing early without paying taxes.

Some more fine print...

There are a few more minor differences between the two. In a traditional IRA, you must start taking your money out of the account when you reach the age of 70 1/2. This is not true of ROTH IRAs. Also, ROTHs are limited only to people of a certain income. Currently individuals earning more than $95,000 per year, or couples earning more than $150,000 cannot participate in the ROTH program.

The big picture

While there are many differences between the two programs, they both have one thing in common: Your money grows tax-free in both accounts. This makes them incredibly powerful for building your retirement fund. They also both have contribution limits every year, so if you miss a year, you can't catch up. These two facts together suggest that it's vital that you start making the most of these opportunities as soon as possible! Happy Retirement!

Photo Source: Peter Kaminski