Traditional IRA vs. Roth IRA, which should you open?


This is a common question that comes up with many people looking to open an individual retirement account (IRA). I’ll make this as short as possible, and you can decide for yourself which IRA is best for you. 

Traditional IRA

Definition: A traditional IRA is a tax-deferred retirement fund, and the contributions may be tax deductible depending on your income and tax filing status. The contributions are made on a pre-tax basis. 
Income Restrictions: There are no income restrictions for the traditional IRA. Everyone can contribute to a traditional IRA, but not everyone can deduct the contributions on their taxes based on your level of income. 
Withdrawals and Distributions: Withdrawals can be made starting at age 59 1/2, but they cannot be made before that without incurring a penalty. Distributions are required to be made at 70 1/2 years old. Check IRS.gov for more information.
Advantages: The advantages all depend on how much you plan on being worth when you are in your retirement years. If you think that you will have more taxable income during your working years or you make too much money to qualify for a Roth IRA, then a traditional IRA is the right choice for you. The biggest advantage is that you can reduce your taxable income during your working years.
Disadvantages: If you are a great saver, and your IRA distributions end up becoming higher than the income in your working years, then you could end up spending more in taxes during retirement than the money you saved in taxes from your contributions. 

Roth IRA

Definition: A Roth IRA is a tax-exempt retirement fund, and contributions are made with after-tax income. Contributions are not tax deductible, but the distributions in retirement are tax free. 
Income Restrictions: Single tax filers cannot earn a gross income of more than $135,000 and married tax filers cannot earn more than $199,000 in order to contribute the maximum amount. Married couples making $189,000 and $199,000 can contribute a reduced amount to a Roth and an income over $199,000 means they cannot put any money into a Roth. The range where you can contribute a portion of the maximum to your Roth is called the phase out limit and for a single person it’s $120,000 to $135,000. A single person making over $135,000 can’t put any money into a Roth. 
Withdrawals and Minimum Distributions: Like the traditional IRA, the minimum age to start withdrawing funds is 59 and a 1/2 years old. The principal amount can be withdrawn at any time, if you take out earnings early you will incur a steep penalty. The Roth has no minimum distribution requirements. 
Advantages: The biggest advantage is not worrying about taxes during retirement. You pay income tax on the money when you earn it but don’t owe any taxes when you take distributions. If your money has been in a Roth for decades it’s hopefully been growing as the value of your investments increase. When you sell those investments you won’t have to pay taxes on your distributions so you aren’t taxed on that growth. If you will earn more in retirement distributions than you do during your working years, then the Roth IRA is for you. Also, not being required to make minimum withdrawals is a very nice thing. 
Disadvantage: Contributions are not tax deferred so you don’t lower your income taxes for the year you make the contribution. Not everyone qualifies for the Roth IRA, so high-income earners don’t have the option of opening one.
Traditional IRA or Roth IRA? Not only should you calculate how much income you think you’ll have in retirement vs today, you also have to consider how tax laws will change over time.  It’s hard to know what the tax code will look like decades from now when it’s time for you to retire.  There’s been a lot of talk about tax reform lately but no one really knows when or if it will happen.
Some people think that taxes will inevitably be higher across the board in the future to help fund social programs like Social Security, Medicaid, and Medicare.  Others believe that the US government will keep tax rates relatively low and won’t adopt the high tax rates that many European countries use.
Opening an IRA
No matter what, you should strongly consider opening an IRA account as you first investment account. It is a powerful retirement vehicle that not enough people utilize.  Talk with your financial advisor about the advantages and disadvantages before you open your account.

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