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What's the Difference Between a Roth and Traditional IRA?

Posted by Michael J. O'Connor | CWS®, Vice President Investments
April 18, 2017

difference-between-Roth-and-Traditional-IRA.pngBoth a Roth IRA and Traditional IRA (Individual Retirement Account) can potentially help meet your retirement savings goals. The main difference between the two is: with a Roth IRA, taxes are paid upfront, whereas contributions to a Traditional IRA are made “pre-tax,” and reduce taxable income for the year.

Age and income are two significant factors to consider when choosing a Roth or Traditional IRA. Couples or individuals in a low tax bracket as well as younger people may be better off with a Roth. Earnings grow tax-free, and contributions can be withdrawn at any time without penalty. Individuals or couples in a higher tax bracket may choose a Traditional IRA to reduce their taxable income, or because their income is too high to qualify for a Roth. A Traditional IRA is also a good choice for people who expect to be in a lower tax bracket during retirement.

Income and Age Limits

Anyone 70 ½ or younger can contribute to a traditional IRA, but Roth IRAs have income restrictions:

  • Single tax filers must have modified adjusted gross incomes (AGI) of less than $133,000 in 2017 to contribute to a Roth IRA.
  • Married couples filing jointly must have modified AGIs of less than $196,000 in 2017 to contribute to a Roth.
  • Roth IRAs have no age limitations or minimum required distributions.

If your filing status is single, head of household, or married filing separately and your modified adjusted gross income was more than $118,000 but less than $133,000 there are limitations on how much you can contribute in 2017. The same goes for someone married filing jointly or a qualifying widow(er) with an annual income of more than $186,000 but less than $196,000. Learn more about the Retirement Dilemma for High Income Earners or visit the 2017 Roth Contribution page on IRS.gov for more info.

Contribution Limits

For 2017, total contributions to all IRAs, Traditional and/or Roth cannot be more than $5,500 ($6,500 if 50+) or your taxable compensation for the year, if your compensation was less than $5,500 ($6,500 if 50+).[i] To be clear, the IRS does not allow a $5,500 contribution to a Roth IRA and an additional $5,500 to a Traditional IRA. For a taxpayer under age 50, the annual limit is $5,500 – total.

IRAs and Taxes

Traditional IRAs allow the taxpayer to save now, pay later. Contributions to a Traditional IRA are tax-deductible on both state and federal tax returns, but Uncle Sam takes his cut when the money is withdrawn. Be careful: the tax-deductible amount can be reduced or eliminated if your spouse participates in a retirement plan with their employer.

With a Roth IRA, taxes are paid on the initial contribution, but earnings and withdrawals are generally tax-free. Contributions to a Roth IRA are not eligible for a tax-deduction.

Roth IRA Pros and Cons

Pros: Contributions can be made at any age, withdrawn at any time and there are no minimum required distributions at 70 ½. There is a 10% early withdrawal tax if earnings are withdrawn before age 59 ½; otherwise, earnings grow tax-free. After five years, up to $10,000 in earnings can be withdrawn penalty-free to cover first-time homebuyer expenses.

Cons: Not everyone qualifies for a Roth due to income limits, and contributions are not tax deductible.

Traditional IRA Pros and Cons

Pros: You can contribute if you (or your spouse if filing jointly) have taxable compensation.

Cons: Withdrawals from a Traditional IRA are taxable. Persons 70 ½ or older must take minimum required distributions and can no longer contribute to a Traditional IRA. Any withdrawals taken before age 59½ incur a 10% federal tax penalty. Up to $10,000 may be withdrawn for first-time homebuyer expenses without penalty, but they are still taxed as income.

Which IRA is Better: Roth or Traditional IRA?

A Roth IRA might be a good choice if: you expect to be in a higher tax bracket in retirement, or if there’s a chance you’ll need to withdraw contributions before you retire. Roth IRAs can potentially be a better choice for wealth-transfer as they grow tax-free.

A Traditional IRA might be a good choice if: your income is too high to qualify for a Roth IRA and/or you’re looking to reduce your taxable income. A Traditional IRA is also a good choice if you expect to be in a lower tax bracket in retirement.

Can’t Decide? A Wealth Manager Could Help. Making an informed decision about which IRA type is right for you (and there are 11 in total) can impact your compounding interest over the long run. If you have $500,000 or more to invest, a WrapManager Wealth Manager can help you make an informed decision about which IRA is right for you. To learn more about what investment vehicles might best suit your lifestyle, or to get started investing today give us a call at 1-800-544-7774 or drop us an email at wealth@wrapmanager.com.

Want to learn more about retirement planning? There is a free eBook on different ways you can enhance your retirement planning here


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