Traditional IRA vs. Roth IRA: Which One is For You?

Retirement |

It's tax season, which means for many investors, it's time to make important financial decisions regarding where to direct funds their retirement funds. For those that don't have employer-sponsored programs like a 401k or pension plan, an individual retirement account allows them to save money for retirement while taking advantage of tax breaks. Individual retirement accounts come in two varieties -- traditional and Roth -- and while both are very similar, they have a couple of distinct differences. Here's a quite breakdown of things to consider.

Timing of Tax Savings

With a traditional IRA, the government allows you to save $5,500 a year ($6,500 if you are 50 or older) without having to pay taxes on it. This allows your money to grow tax-free and not pay any taxes until you withdraw it.

The upfront tax break is not available with a Roth IRA, but all the money in the account, including investment earnings, can be withdrawn tax-free in retirement. If you contribute $100,000 over the life of a Roth IRA and your account grows to $300,000, the additional $200,000 is tax-free.

One of the main advantages of the Roth IRA is that, because you have paid taxes on your contributions, you can withdraw that money anytime from the retirement account tax- and penalty-free, even if you are younger than the government minimum retirement age of 59 1/2. With a traditional IRA, early withdrawals are taxed, and you could face an additional tax penalty of 10 percent if the withdrawal from your retirement account is not for a qualified purpose.

Required Minimum Distributions

Though the government encourages retirement savings in an IRA by offering a tax break, it eventually wants to get the taxes due on the money, which is why it requires you to start withdrawing from a traditional IRA at age 70 1/2. There is a formula that dictates how much you must withdraw, and if you don't do so, you face a 50 percent tax penalty on the amount you should have withdrawn. Required minimum distributions are not required with a Roth IRA, since the contributions to the account have already been taxed.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please go to: http://www.equities.com/disclaimer

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