Mar 10

Hi. JustĀ  wanted to see if anybody could explain to me the difference between Roth and Traditional IRAs.Many thanks

5 comments so far...

  • zaphodsclone Said on March 10th, 2010 at 8:04 pm:

    Depending on how much you earn:

    Most people that do a traditional IRA can deduct the amount contributed from that years taxable income.

    The Roth money isn’t deducted from that years income on taxes but when you take the money out at retirement it isn’t taxed as opposed to the traditional IRA which is taxed when you withdraw it.

    For most people the Roth is the better of the two options but not always.

  • zabba33 Said on March 10th, 2010 at 8:30 pm:

    The IRA account is tax deferred ( you do not pay the tax until you use the money). The Roth is tax free when you use the money because you pay the tax when you put it in the account.

  • Automation Wizard Said on March 10th, 2010 at 8:49 pm:

    The biggest difference is when the government takes more than their share out of your money.

    Also, with Roth you can remove your principle much easier.

  • vegas_iwish Said on March 10th, 2010 at 9:02 pm:

    If you need a tax deduction now traditional better but if young there is a trade-off. Money will grow a lot if invested properly and will have to pay taxes on all of it. Of course those tax dollars will be in depreciated money after decades of inflation so not quite as simple as some make it sound.

  • Thomas Z Said on March 10th, 2010 at 9:48 pm:

    Traditional IRAs
    The tax breaks for a traditional IRA are of the “this is tax-deductible” kind. That means that, depending on previously discussed factors, the money you deposit in your IRA isn’t taxed. And regardless, whatever earnings you have on your contributions won’t be taxed until you withdraw that money many years later.

    For example, let’s say you made $30,000 during the year, and you put $2,000 of it into an IRA. You would pay income tax on only $28,000. Additionally, your deposit will grow free of tax through the years. When you finally withdraw the money for your retirement — after age 59 1/2 — then, and only then, will the money be taxed as income at your ordinary income tax rate.

    If you withdraw the funds before age 59 1/2, then in most cases you’ll have to pay both income tax and a 10% penalty on whatever earnings have accrued — but if the funds are used to pay for “qualified higher education expenses” or for one of the other eight exceptions to the 10% early withdrawal penalty, then the penalty will be waived.

    Remember that you can put just about anything you want in an IRA account. Under the onslaught of marketing from banks, you may have come to the conclusion that an IRA is somehow connected to a CD (certificate of deposit). This is because that is what most banks sell.

    The Roth IRA
    The tax breaks for a Roth IRA are different. Unlike a contribution to a traditional IRA, a Roth IRA contribution is never deductible. Taking the above example, you’d still be taxed on $30,000 even though you had put the same $2,000 into a Roth IRA. However, when you withdraw the money from a Roth IRA, none of it — and that includes the earnings — will be taxed, assuming that the Roth IRA has been open for at least five tax-years and you are older than age 59 1/2. That’s right — you get off scot-free with the booty. All you have to do is to wait until you can withdraw it penalty-free. Again, that’s after age 59 1/2, and as long as it’s been in there for at least five years.

    In other words, the Roth offers tax-exempt rather than simply tax-deferred savings. One word makes a big difference. While both allow you to accumulate wealth without paying taxes along the way on your profits, the traditional IRA ultimately sticks you with a tax bill for those profits (plus your initial contributions if those were deducted when made). The Roth doesn’t. As long as you follow the rules, you never pay taxes on your gains. So paying the piper now before contributing to the Roth may work out to be better for you than paying him later on your investment profits.

    The Roth makes particular sense for people otherwise limited to making non-deductible contributions to a regular IRA. And the Roth is fully available to single filers making up to $95,000 and couples making up to $150,000. It also allows you great flexibility by allowing you, in many cases, to withdraw your principal contributions at any time tax-free, without penalty. First-time homebuyers can also pull out $10,000 in profits penalty free and tax-free if the money has been in the Roth IRA for at least five tax years. There are also some breaks for education spending, though an Education IRA may be a better vehicle for education savings. Barring these exceptions, though, profits withdrawn before retirement age and before the money has been in the Roth for at least five tax-years will be taxed, plus you’ll also incur a 10% penalty when those earnings are taken before age 59 1/2.

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