Roth IRA Vs. Traditional IRA

Two of the most popular forms of Individual Retirement Accounts (IRA) are the Roth IRA and the traditional IRA. So, what is the difference between them? Both have their share of advantages and disadvantages and it is always good to examine them before taking the decision for which form of retirement planning to pick, as it can have pretty big financial effects.

Comparing the Two Retirement Plans

The general trend has shown that the traditional IRA and Roth IRA contribution limits are pretty much the same. So, in this debate, we will look at the salient features of both these types of retirement plans, so that you will be able to pick the plan which is best suited for your financial needs.

Traditional IRA
Perhaps the biggest factor is the tax treatment for both these forms of retirement accounts. The traditional IRA works on a simple principle that when the money goes into your retirement account, you have a tax deduction for that amount outright. Say you make USD 60,000 a year and put in USD 3,000 as your IRA contribution, that amount will be deducted from your taxable income and you will have to pay tax on $57,000 less any other deductions as applicable. On the other hand, when you withdraw money from the IRA after celebrating your 59½ birthday, then every withdrawal will be taxed according to the tax rate at the time of withdrawal. So that tax isn't waived off, it is deferred.

The other very important details of the traditional IRA which you need to know in order to make the decision between either is that you need to withdraw all your money before you're 70½ years old. If you withdraw the money before turning 59 ½, you will have to pay the penalty for early IRA withdrawal of 10% of the withdrawn amount. Of course, there are certain exceptions to that rule which you could use.

Roth IRA
The second type of retirement plan is the Roth IRA. Like I said, the difference between Roth IRA vs traditional IRA is largely restricted to the difference between their tax implications. A person with Roth IRA retirement plan, has to pay tax on the entire amount which he earns, irrespective of how much of it goes into the retirement account. Contributions to the Roth IRA are not tax deductible. So if the fellow in the previous example makes puts USD 3,000 of his USD 60,000 earnings into the Roth IRA account, he still pays tax on USD 60,000 less any further deductions.

Not happy with it, are you? Well, you will certainly have a surprise on the day you turn 59½, because from that day on, any withdrawal from the Roth IRA account is tax free. Makes sense, doesn't it? You paid the tax on it before and now it's all free of tax.

Of course, there is the little matter of the annual income when it comes to the Roth IRA plan. Now, you must know you only qualify for the Roth IRA if your individual income is below USD 95,000 or your combined income with your spouse is USD 150,000 or less. Also, the Roth IRA has no mandatory distribution age and can be withdrawn any time over the life of the account holder. The Roth IRA contribution limits is the same as the contribution limit for the traditional IRA.

While there are other seemingly minor differences, the main one is related to the treatment of tax. So, pick one which you think is best suited to your needs!