What Is the Difference Between a Traditional IRA and a Roth IRA?

A traditional IRA, or Individual Retirement Account, allows you to put money in an investment on a pre-tax basis to save for retirement. For example, if you made $50,000 in salary for the year, and you contribute $4,000 to a traditional IRA, you will be taxed on $46,000 of income. $50,000 - $4,000 = $46,000. This can be a great tool for people that are looking for a reduction on their taxes for the year. But while the traditional IRA saves you tax dollars now, it will be fully taxable when you withdraw the funds. Whatever you withdraw will be added to your taxable income for the year and taxed at the applicable rate.

A Roth IRA works in a way that is almost opposite of the traditional IRA. If you contribute to a Roth IRA, you receive no reduction in your taxable income. Therefore, all contributions are after tax. However, when you withdraw funds from a Roth IRA, nothing is taxed. This means that any growth that takes place in the account is potentially tax free, as long as you have had the account longer than 5 years. This account is ideal for those already in low tax brackets who want to contribute to retirement or for those who prefer the Roth tax model.

Take note that the funds should be left in the IRA until age 59 ½ or there may be tax penalties on money withdrawn from the account. Also, investment performance of an IRA is dependent on what type of investment you choose. There are almost limitless options, so consider carefully your risk tolerance and time horizon.

There are many rules, restrictions, exceptions, and other factors to consider when investing in an IRA. Be sure you consult with a qualified tax advisor and investment consultant when making your decision.