What’s the difference between a Roth IRA and a traditional IRA?
A Roth IRA you contribute after tax dollars, meaning you get no tax benefit from making the contribution. You get tax free growth and when you withdraw the funds, it’s tax free. There is also no required distributions with Roth IRA’s.
With a tradtional IRA, you contribute before tax dollars. It reduces your taxable income by the amount you contribute. Say your taxable income is $50,000 and you make a $5,000 IRA contribution. Your taxable income is now $45,000. You still get tax free growth, but it’s deferred. When you make withdrawals from your traditional IRA, you pay ordinary income tax on the amount withdrawn. You are also required to start taking distributions at age 72.
The contribution limits for both a traditional IRA and Roth IRA are $6,000 for 2019 and 2020 with a catch up of $1,000 if you are over 50. You have until April 15th to make a contribution for the previous year.
There are some income limits with both types of IRA’s that may limit what you can do. Roth IRA’s have income limits of $196,000 for married filing jointly and $124,000 where the ability to make contributions is limited and eliminated at $204,000 and $139,000.
For the traditional IRA and you are covered by an employer’s retirement plan, the ability to deduct the income is limited starting at $103,999 for joint and $64,999 for an individual.
So what do you choose. As with most aspects of financial planning, it depends on your situation. If you know you’ll be in a lower tax bracket in retirement, choose the traditional IRA. If you know you’ll be in a higher bracket in retirement, choose the Roth. That’s likely hard for most people to know that far in advance. In general, the younger you are, start with a Roth. Having the growth and withdrawals tax free and no required distribution is a great advantage. Your income may also play a role in what’s available to you with the limits mentioned above.
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