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Do You Have the Right IRA for Your Retirement?

A football team wouldn’t head into a championship game—or even have made it there—without a solid game plan, right? Of course not! Winning isn’t an accident. And the same is true when it comes to your money goals. In the game of retirement investing, knowing the differences between a Roth IRA and a traditional IRA can help you create a winning game plan.

An IRA (Individual Retirement Arrangement) is a retirement savings account providing tax advantages (more on that later) for retirement savings. Depending on your retirement dreams, you may need more income in retirement than you think to support your lifestyle. Employer-sponsored plans, like a 401(k), might not cover the savings you need. So, an IRA can help you to retire inspired.

Traditional vs. Roth: What Do They Have in Common?

Traditional IRA and Roth IRA

You can contribute if you (or your spouse if you filed taxes jointly) have income from a job.

You can contribute up to $6,000 ($7,000 if you’re age 50 or older by the end of the year), or an amount equal to your income for the year if it was less than the contribution limit.

You and your spouse can each have an account.

Withdrawals made before you turn 59 1/2  will be subjected to taxes and an additional 10% penalty. 

You can contribute funds at any time during the year or by the deadline for filing your tax return the following year.

 

Traditional vs. Roth: What Makes Them Different?

The main difference between a Roth IRA and a traditional IRA is how they’re taxed. Take a look at a side-by-side comparison.

Traditional IRA

Roth IRA

In most cases, contributions are tax deductible.

Contributions are not tax deductible.

There are no annual income limits on contributions.

In 2020, you can contribute up to the limit if your income is less than $124,000 for single filers and $196,000 for married couples filing jointly.

You must make annual withdrawals from your IRA after you turn 72.

No withdrawals required if you are the original owner. 

You must pay taxes on withdrawals in retirement.

You are not taxed on qualified withdrawals in retirement. 

Tax Deductions

With traditional IRAs you can deduct contributions on your annual tax return. The amount of the deduction depends on your filing status, income, and whether you have access to a workplace plan. Roth IRA contributions are not tax deductible. But paying your taxes up front has its perks (more on that in a minute).

Distributions and Withdrawals

A distribution is when you take money out of your IRA penalty free. It doesn’t trigger the 10% penalty because you’re:

  • 59 1/2 or older, or

  • Rolling the money from one qualified plan to another, like a 401(k) to an IRA.

For traditional IRAs, you’ll be required to start taking minimum distributions when you turn 72. If you have a Roth IRA, you won’t be required to take any minimum distributions.

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Now, early withdrawals, on the other hand, are where we sometimes do stupid. This is when you withdraw money from your IRA before age 59 1/2. When you do that, you’ll get slapped with a 10% early withdrawal penalty. Not to mention, you’re taking out money that would otherwise continue to earn more money and grow. Don't do it!

Taxes on Withdrawals

If you withdraw funds after 59 1/2, you’ll be taxed at your current tax rate for any traditional IRA distributions. With Roth IRAs, your withdrawals are completely tax-free. That’s worth repeating: Your Roth distribution is not taxed. Being able to withdraw all the money you have accumulated during your working life tax-free is like an investing self-high five. That’s why whenever we say “Roth” it just makes us happy because you have tax-free growth, with after-tax dollars doing tax-free stuff!

Roth or Traditional?

Okay, we’ve broken down into a little more of what each of these retirement investment vehicles brings to the table. At the end of the day, we favor the Roth for its tax-free growth and distribution perks. In almost every situation, it’s the best option out there for building wealth and saving for your dreams! However, there are a few exceptions based on your age and specific retirement goals.2 You need to understand where you are in your retirement game-planning journey.

Talk With an Investing Pro

That’s why when it comes to finding the right retirement investing choices for your situation, we always recommend getting with an investing professional. A SmartVestor Pro can help you understand your options and figure out what works for your specific circumstances. Remember, a dream without a plan is just a wish!

Ramsey Solutions

About the author

Ramsey Solutions

Ramsey Solutions has been committed to helping people regain control of their money, build wealth, grow their leadership skills, and enhance their lives through personal development since 1992. Millions of people have used our financial advice through 22 books (including 12 national bestsellers) published by Ramsey Press, as well as two syndicated radio shows and 10 podcasts, which have over 17 million weekly listeners.

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