If you’re like most people, the world of IRAs and investment accounts can be confusing. There are so many different options, and it’s hard to know which one is right for you. Do you want a ROTH IRA or a Traditional IRA? What’s the difference? And how do you even pronounce “IRA” anyway? (It’s eye-rah, by the way.)
Don’t worry; we’re here to help. This blog post will break down the key differences between a ROTH IRA and a Traditional IRA. By the end, you should have a good idea of which account is right for you. So let’s get started!
ROTH or a Traditional IRA: The Basics
The biggest difference between a ROTH IRA and a Traditional IRA is how and when your money is taxed. With a Traditional IRA, you get an up-front tax deduction when you contribute to your account. This means that your money goes in pre-tax and grows tax-deferred until you retire. Then, when you start taking retirement distributions, all that money is taxed as ordinary income.
With a ROTH IRA, you don’t get an up-front tax deduction—meaning your contributions are made with after-tax dollars. However, your money grows tax-free, and when you take distributions in retirement, none of that money is taxed. So which one is better? It depends on a few things…
ROTH or a Traditional IRA: It Depends…
Your Tax Bracket Now vs. Later: Suppose you expect to be in a lower tax bracket when you retire than you are now. In that case, a Traditional IRA might be the better choice because it allows you to defer taxes until later. On the other hand, if you expect to be in the same or higher tax bracket when you retire, then a ROTH IRA might be better because it allows you to pay taxes now at your current rate, and then all future growth is tax-free.
Your Time Horizon: If you’re close to retirement (say, within 10 years), then a Traditional IRA might be the better choice since you won’t have to pay taxes on your withdrawals until you actually start taking them out. However, if you’re still early in your career with many years until retirement, then a ROTH could make more sense since your money will have longer to grow tax-free.
There’s no right or wrong answer here—it really depends on your personal situation and what makes sense for you. The best thing to do is talk to a financial advisor who can help crunch the numbers and figure out what makes the most sense for your situation.
Charles Schwab has a handy calculator to help you see the impact and growth potential between the two.
In conclusion, there are pros and cons to both ROTH IRAs and Traditional IRAs. It really depends on your circumstances as to which account makes the most sense for you. A financial advisor can help crunch the numbers and determine what’s best for your situation.