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December 4, 2024

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Not sure whether to choose Roth vs. Traditional IRA? This post will explain the differences, including tax savings and withdrawal rules, to help you decide which is the right fit for you! 

Choosing between a Roth vs. Traditional IRA is one of the most important financial decisions you’ll make for your retirement.

Both types of individual retirement accounts (IRAs) come with distinct tax advantages, and understanding the key differences is crucial to making an informed choice.

While a Traditional IRA offers tax breaks on contributions, a Roth IRA provides tax-free withdrawals in retirement, making each account better suited to different financial situations.

In this post, we’ll explore the main differences between Roth and Traditional IRAs, helping you decide which option aligns best with your financial goals and retirement strategy.

FAQs

Q1: What is the key difference between Roth and Traditional IRAs?

A1: A Roth IRA is funded with after-tax money, meaning withdrawals in retirement are tax-free, whereas Traditional IRA contributions are made pre-tax, with withdrawals taxed as income.

Q2: Should I choose a Roth or Traditional IRA?

A2: It depends on your current tax bracket and expected tax bracket in retirement. If you anticipate being in a higher tax bracket later, a Roth may be more beneficial.

Q3: What happens if I withdraw from my IRA early?

A3: Withdrawing from a Traditional IRA before 59½ may incur a 10% penalty and taxes, while Roth IRA contributions can be withdrawn at any time tax-free, but earnings may be subject to penalties.

Q4: Are required minimum distributions (RMDs) mandatory for Roth IRAs?

A4: No, Roth IRAs are not subject to RMDs during your lifetime, which can be an advantage for estate planning.


Traditional vs. Roth IRA Contributions

Traditional (or pre-tax) contributions are deducted from your paycheck before taxes, resulting in a lower current tax bill, and withdrawals are taxed as ordinary income.

Roth contributions are considered “after-tax,” so they won’t reduce the amount of current income subject to taxes, but qualified distributions down the road will be tax-free (under current law).

When deciding between traditional and Roth contributions, think about whether you are likely to benefit more from a tax break today than you would from a tax break in retirement.

Specifically, if you expect to be in a higher tax bracket in retirement, Roth contributions may be more beneficial in the long run

Lastly, there’s another new rule that could impact your contribution decisions over the coming years. Starting in 2026, all of your catch-up contributions will have to be Roth contributions if you earned more than $145,000 during the previous year.

Splitting your contributions between traditional and Roth accounts could help create a wider range of future options

Penalties For Early Withdrawals

Withdrawals from pre-tax retirement accounts prior to age 59½ and nonqualified withdrawals from Roth accounts are subject to a 10% penalty on top of ordinary income taxes.

However, because Roth contributions are made with after-tax dollars, they can be withdrawn at any time without tax consequences.

A Roth distribution is considered qualified if the account is held for five years and the account owner reaches age 59½, dies, or becomes disabled.

Other exceptions may apply

Required Minimum Distributions (RMDs)

You should also consider that generally you will have to take taxable required minimum distributions (RMDs) from traditional accounts once you reach age 73 (or 75, depending on year of birth), whether you need the money or not.

Roth accounts are not subject to RMDs during your lifetime, which can make them useful for estate planning purposes. This also provides flexibility to make withdrawals only when necessary and could help you avoid unwanted taxes or Medicare surcharges.

The decision between a Roth vs. Traditional IRA ultimately depends on your current and expected future financial situation. If you’re looking to benefit from tax breaks today and expect to be in a lower tax bracket during retirement, a Traditional IRA may be the better choice. On the other hand, if you anticipate being in a higher tax bracket in the future, or if you’re looking for more flexibility in your retirement planning, a Roth IRA could provide greater long-term benefits. If you’re still unsure, splitting your contributions between both types of accounts can offer a balance of advantages, giving you more options as you approach retirement.

Remember, planning ahead and understanding the impact of taxes now versus in the future will help ensure you make the best decision for your financial future.

Contact your tax and financial advisors to determine the best moves for your situation.


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