Traditional IRA vs. Roth IRA: Key Differences and Why You Should Contribute
When planning for retirement, choosing the right investment vehicle is crucial. Two popular options—Traditional IRAs and Roth IRAs—offer unique benefits that can help you secure a financially stable future. Understanding their differences and the importance of consistent contributions can set you on the path to retirement success.
What is a Traditional IRA?
A Traditional Individual Retirement Account (IRA) allows you to save for retirement with pre-tax dollars. Contributions may be tax-deductible, which means you can reduce your taxable income for the year you contribute. The funds in a Traditional IRA grow tax-deferred, meaning you won’t pay taxes on the earnings until you withdraw them in retirement.
Key Features:
- Tax Advantages: Contributions may lower your taxable income in the year they’re made.
- Required Minimum Distributions (RMDs): Starting at age 73 (as of 2023), you must begin taking annual withdrawals.
- Withdrawal Taxes: Withdrawals are taxed as ordinary income.
What is a Roth IRA?
A Roth IRA, by contrast, is funded with after-tax dollars, meaning contributions are not tax-deductible. However, the big advantage is that your investments grow tax-free, and qualified withdrawals in retirement are also tax-free.
Key Features:
- Tax-Free Growth: Earnings and withdrawals are tax-free if certain conditions are met.
- No RMDs: Unlike a Traditional IRA, Roth IRAs don’t require distributions during the account holder’s lifetime.
- Income Limits: Eligibility to contribute phases out for higher-income earners. For 2024, the phase-out begins at $138,000 for single filers and $218,000 for married filing jointly.
- Flexibility: Contributions (but not earnings) can be withdrawn at any time without penalties.
Why It’s Important to Contribute
1. Take Advantage of Compound Growth
The earlier you start contributing, the more time your investments have to grow through compounding. Even small, regular contributions can lead to substantial savings over decades.
2. Tax Benefits
Both Traditional and Roth IRAs offer tax advantages, either up front (Traditional) or in retirement (Roth). These benefits can significantly enhance your overall savings.
3. Retirement Security
Social Security benefits may not be sufficient to maintain your desired lifestyle in retirement. An IRA provides a personal safety net to supplement other sources of income.
4. Flexibility
With a Roth IRA, you have more control over your withdrawals in retirement and no RMDs, making it an excellent option for long-term planning.
Which IRA is Right for You?
The best choice depends on your current financial situation and future goals:
- Choose a Traditional IRA if you expect to be in a lower tax bracket in retirement or want to reduce your taxable income today.
- Choose a Roth IRA if you anticipate being in a higher tax bracket in retirement or prefer the flexibility of tax-free withdrawals.
In some cases, contributing to both types of IRAs can provide a balanced strategy to manage taxes now and in the future.
Final Thoughts
Contributing to an IRA—whether Traditional or Roth—is a powerful step toward financial independence in retirement. Take time to evaluate your income, tax situation, and long-term goals to determine which account best suits your needs. Regardless of your choice, consistent contributions will pay dividends for your future self.
*Content Prepared by Jonathan Neher
Securities offered through Registered Representatives of Cambridge Investment Research, Inc., a broker-dealer, member FINRA/SIPC. Advisory services offered through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Avenues to Wealth Financial Advisors and Cambridge are not affiliated.
