There is no right answer. Real helpful, huh? To elaborate, the answer depends on your unique financial circumstances and goals. To determine which retirement plan is best, you will want to consider a few important questions. Where are you now? Where will you be when you retire? How will you get there?
Both forms of the IRA are great ways to save for retirement, although each offers different advantages.
Traditional IRA:
- Tax deductible contributions (depending on income level)
- Withdraws begin at age 59 1/2 and are mandatory by 70 1/2
- Taxes are paid on earnings when withdrawn from the IRA
- Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
- Available to everyone; no income restrictions
- All funds withdrawn (including principal contributions) before 59 1/2 are subject to a 10% penalty (subject to exception).
Roth IRA:
- Contributions are not tax deductible
- No Mandatory Distribution Age
- All earnings and principal are 100% tax free if rules and regulations are followed
- Funds can be used to purchase a variety of investments (stocks, bonds, certificates of deposits, etc.)
- Available only to single-filers making up to $132,000 or married couples making a combined maximum of $194,000 annually.
- Principal contributions can be withdrawn any time without penalty (subject to some minimal conditions).
Tax Deferred vs. Tax Free
The biggest difference between the Traditional and Roth IRA is the way Uncle Sam treats the taxes. If you earn $50,000 a year and put $2,000 in a traditional IRA, you will be able to deduct the $2,000 from your taxes (meaning you will only have to pay tax on $48,000 in income to the IRS). At 59 1/2, you may begin withdrawing funds but will be forced to pay taxes on all of the capital gains, interest, dividends, etc., that were earned over the past years. The Traditional IRA is therefore tax deferred.
On the other hand, if you put the same $2,000 in a Roth IRA, you would not receive the income tax deduction. If you needed the money in the account, you could withdraw the principal at any time (although you will pay penalties if you withdraw any of the earnings your money has made). When you reached retirement age, you would be able to withdraw all of the money 100% tax free. The Roth IRA is going to make more sense in most situations. Unfortunately, not everyone qualifies for a Roth. A person filing their taxes as single can not make over $132,000. Married couples are better off, with a maximum income of $194,000 yearly.