It's never too early to start saving for retirement. Although work-sponsored retirement accounts are a fantastic way to save money, don't forget about individual retirement accounts (IRAs). There are two types of IRAs available—traditional and Roth—and the type you choose will significantly impact how you contribute to the account, how you withdraw your savings, and the taxes you pay, amongst other considerations. So you might be wondering, traditional vs. Roth IRA: which is best? The truth is, it's not that simple. Different retirement accounts suit different people. Read on to learn about the various factors to consider when choosing between the two.
Anyone with taxable income is able to create and contribute to a Roth IRA. Although traditional IRAs are also quite welcoming, no matter what your age, they have a cutoff point at age 70½. If you're over 70½, a Roth IRA is your only option.
Although most people are eligible to contribute to both types of IRAs based on their income, there are limits to Roth IRAs. The numbers fluctuate depending on the year. In 2015, for example, single filers (full contribution) can earn up to $116,000, and joint filers (full contribution) can earn up to $183,000. If your income is near this limit, check the numbers before you commit to a Roth.
Unfortunately, you can't contribute as much money as you like to your IRA. In the 2015 tax year, you're allowed to contribute $5,500 to either IRA if you're under age 50. If you're older than 50, you can contribute a bit more: $6,500. There is no difference between traditional and Roth IRAs. However, it's worth noting that if you have multiple IRA accounts, these limits are the most you can contribute to all of your accounts.
If you and your spouse (if you have one) are not covered by a retirement plan at work, you may be able to deduct some (or possibly all) of your contributions to a traditional IRA account. Unfortunately, this privilege doesn't extend to Roth IRAs.
The major difference between traditional and Roth IRAs? Taxes. One of the great benefits of a Roth IRA is that you will never have to pay taxes on your contribution withdrawals. You also won't pay taxes on your earnings, so long as you remove them after age 59Â½ and follow the 5-year-holding requirement. Traditional IRAs, on the other hand, do require you to pay income tax on withdrawals of earnings and contributions that you deducted from your taxes.
IRA savings are meant for retirement, so you will usually be penalized if you make a withdrawal before age 59Â½. If you have a traditional IRA, you must pay a 10% federal penalty tax on withdrawals of contributions and earnings. Roth IRAs are slightly more forgiving; although the 10% federal penalty tax still applies to withdrawals of earnings, you will not be penalized for withdrawing your contributions.
These are not the only differences between traditional and Roth IRAs, so be sure to do your research before you set up your retirement account. Also, know that it is possible to convert your IRA from traditional to Roth or vice versa.