What to Know About Roth and Traditional IRAs
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A Traditional and Roth are two types of individual retirement accounts, known as IRAs. The main differences are in their eligibility rules when you can withdraw funds penalty-free and in the treatment when it comes to taxes.
Experian details the difference between Traditional and Roth IRAs.
Traditional IRA vs. Roth IRA
Annual Contributions
Both the Traditional and Roth IRA are forms of different individual retirement accounts. In a Traditional account, the IRA is tax-deferred, which means you will pay taxes when you start making withdrawals from the account. The annual contribution limit for a traditional account for 2021 is $6,000, or $7,000 if you are 50 years or older. It is the same for the Roth account as well.
In a traditional account, all earrings and contributions are taxable upon withdrawal. In a Roth account, if you’ve had the account for more than five years and are 59½ years old, or the owner of the account has died, or you are disabled, or you are purchasing your first house (with a limit of up to $10,000), there are no tax or penalties on withdrawals of contributions.
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Tax Deductions
One of the biggest differences between the two accounts is when it comes to tax deductions. In a Roth account, there are no tax deductions. In a traditional account, you can take a full deduction of your IRA contributions on your tax return if you and your spouse do not have access to a retirement plan at work.
Your tax deduction might be capped if you or your spouse has a workplace retirement plan and you can earn above a certain amount, based on your filing status.
Early Withdrawal
When it comes to penalties for early withdrawal, in the traditional account, you will have to pay income tax as well as a 10% penalty if you withdraw before the age of 59½. You can forgo the 10% penalty early withdrawal under certain specific circumstances such as paying for certain higher education expenses or paying for a first home (up to $10,000).
In a Roth account, you will pay a 10% penalty on early withdrawals of earnings if you are under the age of 59½ unless certain circumstances are met such as for higher education expenses or purchasing a first home with a limit of up to $10,000.
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In a traditional IRA account, you must start withdrawing the required minimum distributions by the first of April after you turn 72. In a Roth account, there are no set requirements of minimum distributions during the account owner’s lifetime.
Eligibility
When it comes to income eligibility there are no requirements in a traditional account. You can contribute no matter how much you earn or how old you are. In a Roth account, you cannot contribute if you earn more than $206,000 if married filing jointly, and $139,000 or more if single.
As always you should consult with a financial advisor when it comes to determining which IRA account would best fit your current and future financial needs.
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