Smart Cents

Roth IRA vs. Traditional IRA: Understand the Pros & Cons

When planning for retirement, choosing between a Roth IRA and a Traditional IRA can significantly impact your long-term savings strategy. Understanding the similarities, differences, and current contribution limits for the two types of individual retirement accounts can help ensure you are making informed decisions. Both IRA options offer tools for saving for retirement but do come with their own advantages and rules.

Key Similarities Between Roth and Traditional IRAs

Both Roth and Traditional IRAs require contributors to have earned income in the U.S. and provide flexibility in investment choices. Additionally, both allow account holders to designate beneficiaries for their assets. Contributions for a given tax year can typically be made until April 15 of the following year. For example, if you want to contribute for 2024, you have until April 15, 2025.

Traditional IRA: Tax-Deferred Growth & Required Minimum Distributions (RMDs)

A Traditional IRA can allow contributions to be tax-deductible which a qualified tax professional can confirm based on your specific financial situation. The earnings within the account grow tax-deferred, meaning you won’t pay taxes until you withdraw funds in retirement. This structure can help reduce your taxable income while you’re working and potentially lower your tax burden in the present.

However, withdrawals in retirement are subject to income tax, and account holders must begin taking Required Minimum Distributions (RMDs) at age 72. Early withdrawals before age 59 ½ generally incur a penalty unless they qualify for exceptions, such as certain medical expenses or disaster recovery. Consulting a tax professional is the best way to determine your eligibility for deductions and understand the long-term tax implications of a Traditional IRA.

Roth IRA: Tax-Free Growth & No RMDs

A Roth IRA operates differently by taxing contributions upfront, meaning you won’t get a deduction for contributions. However, the advantage is that your earnings grow tax-free, and qualified withdrawals in retirement are also tax-free. This setup can significantly reduce your tax burden later in life, particularly if you anticipate being in a higher tax bracket during retirement.

Another significant benefit is that Roth IRAs do not have RMDs, allowing your investments to continue growing tax-free for as long as you like. Like Traditional IRAs, early withdrawals before age 59 ½ are subject to penalties unless they meet certain exceptions.

Contribution Limits for 2024

As the 2024 contribution deadline approaches, understanding your IRA contribution limits is crucial. If you're looking for tax savings in the short term, a Traditional IRA may be a suitable choice. On the other hand, if you prefer tax-free income in retirement, a Roth IRA might be the better option. Consulting a tax professional can help determine which IRA aligns with your financial goals, the potential tax benefits you might experience, and how much you can contribute toward your 2024 limit.