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The choice between traditional and Roth IRAs is personal.

The choice between traditional and Roth IRAs is personal.

Even if you are already over 50 years old, there is still time to start saving for retirement. If you have (hopefully) already begun saving for your golden years, you might find that there is still time to change your retirement strategy too. Since traditional and Roth individual retirement accounts (IRA) both encourage Americans to save for retirement through a variety of tax advantages, you might be trying to choose between these two types of plans.

Traditional IRA plans generated a lot of excitement when they were first introduced in the 1970’s. The idea behind them was to give Americans a tax break on retirement savings to encourage people to save and not rely upon social security. However, since taxes are mostly just deferred until retirement, people had to decide if it was better to just get taxes out of the way now or wait until later.

Roth IRAs entered the scene in the late 1990’s. These accounts do not allow people to deduct their contributions, but they do allow for tax-free growth. At retirement, no taxes need to be paid.

How Are Traditional and Roth IRAs Similar

  • Many taxpayers can contribute up to $5,000 to an IRA account.
  • The limit goes up to $6,000 after age 50.
  • In either case, taxpayers risk penalties if they withdraw money before the specified retirement age of 59 ½.

Contribution rules and penalties are different for either type of account. You can learn the specifics of these at the IRS IRA Contribution Limit page.

How Do Traditional IRA Plans Work?

Traditional IRAs are taxed on the back end. In other words, you are postponing taxes on your savings and interest until you take them out during retirement. If you assume that you will pay lower taxes when you retire, because you will make less money, a traditional IRA might be worth considering. But when the tax man finally comes to collect his due, your effective interest rate could be lower than what you really earned.

For example, you may earn an average interest rate of 10 percent over the life of your account. If you have a tax rate of 20 percent when you take out your money, your actual earnings would only be 8 percent. Plus, you still have the delayed tax bill on the savings you contributed when you were working. On the other hand, a tax deduction this year might make it possible for you to save more money.

What’s Different About Roth IRA Plans?  

With a Roth IRA, you do not get to deduct your savings contributions this year. But your account can earn interest without having to report or pay taxes on those earnings. In fact, the money that you take out during retirement is not taxed on the back end. If you assume that your tax rate will be just as high when you retire, or you would rather just get your taxes paid now while you are earning income, you might select a Roth IRA. Since you get to enjoy the benefit of tax free growth now and during retirement, this may increase your effective interest rate over a traditional IRA.

Deciding Between a Roth vs. Traditional IRA

Your choice between Roth vs. traditional IRA plans may come down to a decision to pay taxes now or pay later. The rationale for delaying taxes is that people might expect to be taxed at a lower rate during retirement when they do not actively earn an income. A tax break in the current year might also allow you to contribute more money towards your retirement fund. However, there is no guarantee that you will make less money or be taxed at a lower rate in the future, and some people would simply rather get taxes out of the way during their working years.

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