Roth IRAs Versus Traditional IRAs

Saving for your own retirement outside of government programs such as Social Security is a necessity for a secure future. Fewer companies are offering pensions and Social Security is predicted to need drastic changes to remain viable in the future.

Individuals have multiple retirement account options. Many employers offer 401k or 403b accounts that are tied to your employment.

If your employer doesn't offer one of those options or you simply want to take control of your investment options you look to IRAs.

There are two primary types of IRAs (also known as Individual Retirement Agreements): the Roth IRA and the Traditional IRA.

Roth Individual Retirement Account

The Roth IRA is a retirement account that is funded with post-tax income. You pay taxes on your income this year as you would during any year and invest the funds in the Roth. Since taxes have been paid before investing you never pay income taxes on those funds in the future.

Paying taxes today allows those earnings to grow tax-free until you tap the Roth IRA for retirement. This tax-free investment growth is one of the primary benefits of using this type of account.

Another benefit of the Roth IRA is you allowed to withdraw your contributions at any time. Since tax has been paid on the contributions there is no tax charged and no early withdrawal fee from the Internal Revenue Service.

Also in contrast to Traditional IRAs and 401k plans you are never required to withdraw funds from a Roth IRA. Other plans require you to start withdrawing funds at age 70 and 1/2 regardless of if you need the income or not. A Roth IRA can be held, never touched, and bequeathed to heirs if needed.

Traditional Individual Retirement Account

The Traditional IRA is a retirement account that is funded with pre-tax income. You receive a tax break and delay paying taxes on that income until the funds are withdrawn in retirement.

Compared to a Roth IRA you have more funds to invest due to not paying taxes on those funds. You're taking a tax deduction today and accepting unknown income tax rates in the future. If tax rates rise and you end up paying a higher rate than you would paying taxes today, you've lost money.

With a Traditional IRA you are not allowed to withdraw funds before age 59 and 1/2 without paying penalties and taxes. Early withdrawals pay a 10% penalty to the IRS as well as your standard income tax rate. You can end up paying over 40% of your withdrawal in taxes and penalties.

Additionally IRS rules force you to begin taking minimum distributions (withdrawals) from a Traditional IRA at age 70 and 1/2.

Anyone can contribute to a Traditional IRA regardless of income. However, those contributions are not deductible for all individuals. The Traditional IRA has income limits similar to the Roth IRA income limits.