What do I Need to Know to Make a Roth IRA vs. Traditional IRA Choice?

The Roth IRA vs. the Traditional IRA

September 2012

When it comes to getting an early, smart start on retirement planning, the discussions often come down to a consideration about a Roth IRA vs. a traditional IRA. Both can be great ways to save for retirement. But there are some key differences between the two offerings, as the table below shows.

Traditional IRARoth IRA
How It WorksThe contributions you make usually are tax deductible in the year that you make them. Taxes on the money earned in the IRA are deferred until you take money out in retirement.You don't get a deduction on contributions, but there are no taxes on the money earned in the IRA.
Who Can Contribute
  • Anyone under age 70 1/2 with taxable income (or a spouse with taxable income).
  • There are limits on the tax deduction you can take if you or a spouse are covered by a retirement plan at work.
  • Anyone of any age with taxable income (or a spouse with taxable income).
  • Single filers with income of less than $110,000 or joint filers with income of less than $173,000 can contribute.
LimitationsContribution limits: $5,000 if under age 50; $6,000 if age 50 or older (for tax year 2011).Contribution limits: $5,000 if under age 50; $6,000 if age 50 or older (for tax year 2011).
Taking Money Out (Distributions)

If you take money out before age 59 1/2 , you will have to pay a 10-percent penalty (with some exceptions for certain circumstances).

Distributions taken during retirement after age 59 1/2 are taxed at your tax rate at that time.

You can take your original contributions out at any time, even before retirement, without paying more tax or a penalty.

You can take earnings out without tax or penalty if you are 59 1/2 or older and the money in the IRA has been there for at least five years. If you take money out otherwise, there is typically a 10-percent penalty.

"Both types of IRAs are great tools for retirement," Robert Schmansky, founder of Clear Financial Advisers in West Bloomfield, Michigan, told Ally Bank.

"In general, which one will give you the most benefit depends on your tax rate in retirement when you withdraw the money? With the traditional IRA, you receive a tax-deduction today, and any future money is taxed when withdrawn (hopefully at a lower tax rate in the future).

"With the Roth," he continued, "you pay your tax today, and any future withdrawals of your principal or growth is tax-free. While there are many considerations, if your tax rate is high today, you may benefit more from the traditional IRA."

With your golden years decades down the road, looking at the future can be difficult. But, when you're weighing a Roth IRA vs. a Traditional IRA, it's a good idea to try and consider the overall tax environment that you expect to be in when you retire.

According to Clear Financial Advisers' Schmansky, "It may still make sense to consider a Roth even if you are expecting a lower tax bracket in retirement to diversify your withdrawal options at retirement. If withdrawing money from a traditional IRA will make more of your Social Security income subject to tax, you might have been better off diversifying your IRAs into Roths during your working years, even if you were in a high tax bracket."

To work through such questions, you can get help from a financial advisor as you consider a Roth IRA vs. a traditional IRA. Meanwhile, visit AllyBank.com to see the IRA options available in both categories, or give customer care a call at 877-247-ALLY (2559), where live help is available 24/7.

Related articles: