How is a Roth IRA different from a regular IRA?

January 24, 2020, by John Norris

Both Roth IRAs and Traditional IRAs are great ways for individuals to save for retirement with tax breaks to incentivize doing such. There are several differences between a Roth and traditional IRA such as a Roth never requires you to pull money out at a certain age, and it is easier to pull cash out of a Roth before you retire. However, the main difference between the two is when you get this tax break.

With a traditional IRA, your contributions are considered pretax, so they come out of your paycheck before taxes do, and the taxes are paid when you withdraw the money when you retire. This provides you the benefit of larger contributions that grow without being taxed for decades. A Roth IRA on the other hand, is taxed before the dollars enter the account. This means that when you retire and pull the money out, you don’t have to pay more taxes on it. Both are great options and really the most important thing is that you are saving for retirement. However, there is one overriding questions to ask yourself before deciding which one is better. Do I think I will be making more money when I retire or currently?

Think of it this way, if you are expecting to be in a higher tax bracket at retirement age than you currently are, it would make sense to go ahead and pay the taxes now and let the money grow and not have to worry about taxes again on that money. However, if you think you are going to be in a lower tax bracket when you retire than you currently are, a traditional IRA might make more sense. If you are in a higher tax bracket currently than you are expecting to be in the future, you will get even more benefit from making your contributions pretax.

This sounds simple, however for most individuals, it is hard to forecast their tax situation years in advance. So, what is the best option for those people? Like many answers in investing, the correct one is probably somewhere in the middle. Having a combination of a traditional IRA as well as a Roth IRA will allow you to grow money pretax while also limiting your tax burden when you retire.

This may seem complicated however the biggest contributor to the quality of your retirement is not necessarily whether you have a Roth IRA versus a traditional IRA, but that you are saving money.