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 Funding a retirement account is an important part of your financial planning process. And when it comes to choosing between a Roth IRA and a Traditional IRA, you need to make an informed decision.
Traditional or Roth IRA
While many investors have completely switched to the Roth IRA, that might not be the right choice for everyone. In fact, there are some pretty big advantages that a traditional IRA offers versus the Roth.
That's where we hope to help with this publication - by pointing out the important differences between a Roth IRA and a Traditional IRA. At last count, we've found seven differences between the two IRAs, if you find more let us know. But here is our list:
Age Limit for Contributions
When it comes to age limits, the Roth IRA has an advantage over a traditional IRA.
Income Contribution Limits
- Traditional IRA - While there are limits on how much you can contribute to a traditional IRA, there is no income threshold that determines eligibility to contribute.
- Roth IRA - Depending on your tax filing status, if you earn too much money, you might not be eligible to contribute to a Roth IRA.
When it comes to income limits, the traditional IRA has an advantage over the Roth IRA.
Deductions from Federal Taxes
- Traditional IRA - For the most part your traditional IRA deposits are tax deductible. There are certain eligibility rules depending on your income, tax filing status, receipt of Social Security benefits, or if you are already eligible for a retirement account at work.
- Roth IRA - Tax deductions should never be taken on Roth IRAs.
Here again, the advantage goes to traditional IRAs because unlike a Roth IRA you might be able to deduct your contribution from your taxable income.
Mandatory Distributions
- Traditional IRA - There are minimum distributions you must take from traditional IRAs starting at age 70 1/2.
- Roth IRA - Owners of Roth IRAs are never forced to take a distribution from their account.
When it comes to mandatory or minimum distributions, the advantage goes to the Roth IRA.
Taxing of Distributions
- Traditional IRA - The tax-deferred portion of a traditional IRA distribution is taxed just like ordinary income.
- Roth IRA - In general, distributions taken from a Roth IRA are not taxed.
When it comes to paying income taxes on distributions, the advantage goes to the Roth IRA.
IRS Forms for Contributions and Withdrawals
We mentioned that there are a total of seven differences but we've only shown five so far. That's because the final differences between a Roth IRA and a Traditional IRA have to do with filing paperwork with the IRS.
If you make a non-deductible contribution to a traditional IRA, then you need to file Form 8606. Since Roth IRAs are always non-deductible, you never have to fill out a Form 8606 when making a contribution to your account.
When making a withdrawal, or taking a distribution, from a Roth IRA you always need to fill out a Form 8606. You never have to fill out a Form 8606 for a traditional IRA distribution unless you have made a non-deductible contribution.
Choosing Between a Roth and Traditional IRA
We hope that the above information helps you make a more informed choice when deciding between a Roth and Traditional IRA. We've described seven differences between a Roth versus a traditional IRA and the outcome is pretty evenly divided between the two.
So don't ever let anyone tell you that you should be funding a Roth IRA without first examining the facts - the choice is clearly a personal one and depends on several factors such as income levels and age. If you want to see some of the financial differences between these two accounts, try our Roth vs. Traditional Funds Calculator.
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