If you’ve ever considered retirement savings, then you’ve likely heard talk of individual retirement accounts, or IRAs. A savings account for the long-term sounds like a simple idea in theory, that is until you start digging deeper and find out there are multiple types of IRAs.
Two of the more common types include the traditional IRA and a Roth version. Both offer great opportunities for squirreling away a retirement nest egg, but how do they differ and which one should you consider?
How a Traditional IRA Works
A traditional IRA lets you contribute your pre-tax dollars, which can lower your taxable income for the year you contribute. Your money then grows tax-deferred, meaning you won’t pay taxes on earnings until you withdraw the funds in retirement.
When you begin taking withdrawals, typically after age 59½, those distributions get taxed as ordinary income. Traditional IRAs also require minimum withdrawals starting at a certain age, known as required minimum distributions (RMDs).
This type of IRA can be appealing if you expect to be in a lower tax bracket when you retire than you are today.
How a Roth IRA Works
A Roth IRA works a little differently. Contributions are made with after-tax dollars, so you won’t get a tax deduction up front. However, qualified withdrawals in retirement (including your earnings) are tax-free.
Unlike a traditional option, Roth IRAs don’t require minimum distributions during your lifetime, which can give you much more flexibility with your retirement planning. This can make a Roth IRA especially attractive if you believe your tax rate could be higher in retirement or you need a more diversified tax strategy.
Key Considerations When Choosing
If you’re deciding between a traditional IRA or a Roth IRA, taxes are often the biggest factor. Simply put, with a traditional IRA, you get a tax break now and pay later, but with a Roth IRA you pay taxes now and potentially enjoy tax-free withdrawals later.
Taxes aren’t the only consideration though. Income limits, contribution eligibility, and withdrawal rules can also influence your choice. For example, higher earners may face limits on contributing directly to a Roth IRA, while traditional IRA contributions may or may not be tax-deductible depending on income and workplace retirement plans.
Should You Choose a Traditional IRA or Roth IRA?
There’s no one-size-fits-all answer with choosing one IRA versus another. It truly depends on your financial circumstances now and where they might be in the future.
Many savers choose to use both types over time, which creates a mix of taxable and tax-free retirement income. If you’re unsure which option fits your goals, Space Age credit union always recommends you speak with a financial professional to help you evaluate your current tax situation, long-term plans, and overall retirement strategy.
The important thing is to start saving. Whether you choose a traditional IRA, a Roth IRA or a combination of both, taking steps today can help set you up for a more comfortable retirement tomorrow.
