When deciding which Individual Retirement Account (IRA) is best for your financial situation, there is quite a bit to consider. Traditional IRAs and Roth IRAs are both great ways to start your fund for the future. While they share many similar features, there is one major difference - how and when your money is taxed. 

What is an IRA?

An Individual Retirement Account is an account that has been created for building retirement savings. It is different than keeping your money in a savings account with your bank earning barely anything on interest. An IRA allows you to purchase investments including mutual funds and stocks. Having an IRA can help you save thousands of dollars over the life of the account due to the tax breaks you may be eligible for.

An average savings account interest pays less than 1%, so it's a good idea to diversify your savings vehicles.

How do you know which IRA works best for you?

Choosing between a traditional or Roth can be a difficult decision. There are many different perks that not everyone is potentially eligible for when it comes to a traditional IRA and Roth IRA. Your income level is a determinant of whether you are allowed to contribute to a Roth IRA. But on the other hand, anyone is eligible to contribute to a traditional IRA regardless of your stated income. What you contribute to your traditional IRA that you are allowed to deduct from your taxes is limited to your income and your spouses income or your access to a work retirement plan.


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Traditional IRA

Looking for a tax break on the year of your contribution instead of when you retire? You might have come across the right choice.

Many who are subject to a high tax bracket and expect to be in a lower tax rate when retirement rolls around tend to gravitate towards the traditional IRA for this incentive.

Income does not come into play with a traditional IRA, if you or your spouse do not participate in a retirement plan at work your traditional IRA is fully deductible. If you or your spouse do participate in a retirement plan at work on the other hand, then you will be eligible to partially deduct your traditional IRA contributions if the individual's modified AGI  is less than $74,000 or $123,000 if you are filing jointly. 

Traditional IRAs may be subjected to an early distribution penalty if you withdraw any contributions under the age of 59½. But, you must take a Required Minimum Distribution (RMD) by April 1st of the year after you turn 70½, even if you are not in need of those funds. You will slowly reduce your IRA balance and add the distributed amount to your income.

Roth IRA

If you have no rush to receive your tax break, the Roth IRA may be your best bet. With the Roth IRA, you are allowed to pay the taxes now and receive tax-free distributions later.

With the Roth IRA you are not allowed to deduct the contributions from your taxable income while you're saving but in retirement, your Roth IRA withdrawals are not taxed at all. That is also including your investment earnings for the life of your IRA.

Unlike the traditional IRA with the Roth, you can withdraw money you’ve contributed to your account without any penalty.

For the 2019 tax year, you are eligible to contribute up to $6,000 to your IRA account unless you are 50 or over which at that point you may contribute an additional $1,000 in catch-up contributions.

As mentioned above, qualifying Roth IRA distributions are tax and penalty free. Distributions are qualified if they meet the two requirements:

  • The distribution is taken after the first five years since you first fund into your Roth IRA.
  • The distribution is taken as a result of one of the following:
    • You are 59½ or older
    • You are disabled
    • Your beneficiary receives the distribution upon your passing
    • The amount taken is to purchase your first home

Roth IRAs do not have a requirement to start withdrawing from your retirement, unlike traditional IRAs which are subject to RMD rules.

Key takeaway

Traditional IRA

Roth IRA

Limits for Contribution

The years’ contribution limit (Catch-up contribution for those 50 years or older)

The years’ contribution limit (Catch-up contribution for those 50 years or older)

Tax Deductible

Contribution may be deductibles

Contributions are never deductible

Age Limitations

No contributions allowed after the year the taxpayer attains 70½

No limit

Tax Credit

Eligible for tax ”saver’s tax credit”

Eligible for tax ”saver’s tax credit”

Income Caps for Contribution

No income caps on contribution

Income caps on contribution

Distribution Rules

Distributions can be taken at any time but penalty if the distribution is taken before 59½

Distributions can be taken at any time, also tax and penalty free if qualified

Required Minimum Distribution (RMD)

Owners RMD starts when one turns 70½

Owners are not subject to RMD but beneficiaries are