The Differences Between the Traditional IRA and the Roth IRA

Written by: April Lunar
06/25/2019

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There are many ways to save for retirement. There are the 401(k) contributions you make through your payroll each week. Then there are Individual Retirement Accounts (IRA). These IRAs are a bit different from the 401(k). You can usually not have your retirement contributions for your IRA deducted from your weekly paycheck.

There are many types of IRAs. There are 2 main types of IRAs that many of us are most familiar with. These are the Roth IRA and the Traditional IRA. There are many differences between the 2 main types of IRAs. Most people do not know what these differences are and how that affects their retirement. The main difference between a Roth IRA and Traditional IRA is how the taxes are to be collected on them. This article will lay out some of the differences between the 2 main IRAs and give you a clearer picture of what those differences are and how they will affect your retirement.

What is a Roth IRA

This is the type of IRA that is not deductible. That means you cannot deduct contributions to the Roth IRA on your personal income tax every year. Many people might be wondering why they would want to contribute to a Roth IRA, then. Simply put, a Roth IRA does have tax benefits, You just will not see these tax benefits until you go to withdraw your funds during your retirement.

You see, while a Roth IRA contribution cannot be tax-free before you make withdrawals, it does have its own tax benefits. Those benefits come while you are in your retirement. During your retirement when you make a withdraw from your Roth IRA, you will not be taxed a second time.

Many think this sounds like a good plan. They will get taxed on their contributions but not their withdrawals. Is this the right IRA for you? There are a few questions you will want to ask yourself first. One question is, can you afford to pay the taxes on your contributions?

What is a Traditional IRA?

Like a Roth IRA, a Traditional IRA has both tax implications and tax breaks. These are different from the Roth IRA is how you pay those implications and how you will receive the breaks. The big tax breaks you receive from your Traditional IRA will come while you are still making contributions to it. What we mean is that you will receive a tax deduction dollar for dollar of what you contribute to your Traditional IRA every year. That means you are contributing to a Traditional IRA on a pre-tax basis.

When do you pay the taxes on the money for a Traditional IRA, then? Simply put, you pay the taxes on a Traditional IRA when you withdraw the money from the account during retirement. That is not to say you will owe the taxes on your entire Traditional IRA when you retire. Taxes are only assessed on the money you withdraw from the account.

So, let’s say you were able to contribute $1 Million to a Traditional IRA during your working years. You will not be assessed a tax on the entire $1 Million when you retire. Let’s say you need $5 Thousand per month to live comfortably during your retirement. You would be assessed an income tax on that $5 Thousand per month every year until you pass away. It is that simple, you contribute on a pre-tax basis and they are taxed when you make withdrawals from the account. The less you withdraw the less you will be taxed.

Which IRA is Right for me?

In this article, we have discussed the Traditional IRA and the Roth IRA. We discussed that there are both tax implications and tax benefits for each of the 2 main IRAs that most of us are familiar with in the United States. We discussed that the main difference between a Traditional IRA and a Roth IRA is how the account holder is taxed and what the tax benefits of each one were. So, which of the 2 main IRAs is best for you?

To figure out which of the main 2 IRAs is right for you, sit down with your spouse and do the math. The math might be complicated, but you will want to do it. Simply put, if you are contributing on a pre-tax basis, you will be taxed later. That means you will probably have to make another taxed withdraw to cover the taxes on your withdrawals all year. Is that the right thing for you to do? Maybe you will not want to pay the taxes on your withdrawals.

Contributing to a Roth IRA on a post-tax basis might be the solution you are looking for. You might not want to get that big tax refund back at the beginning of every year. However, you might need that big tax break at tax time every year. After all, we usually pay off credit card debt or put our tax refund to use toward our summer vacation. If that is the case, you might want to contribute toward a Traditional IRA. However, that might not be feasible to do when it comes to making withdrawals from the account.

To be honest, only you can make the decision about with IRA account would be right for you. It is not going to be easy to decide. If you cannot decide easily, it might be a wise decision to go with both the Traditional IRA and the Roth IRA. In doing so, you will not be putting your entire retirement savings in one basket. You will be able to receive the pre-tax benefits on the contributions to the traditional IRA and get a bigger tax refund every year. At the same time, you will be able to not pay the taxes on every withdrawal you make throughout the year. You can withdrawal some of your living expenses from the Roth IRA and some from the Traditional IRA, and be taxed only on the Traditional IRA. 


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