Understanding IRAs | Roth vs. Traditional

When it comes to planning for retirement, the most important step is to start early and begin saving. While there are a few ways to save, Individual Retirement Accounts (IRAs) stand out as a powerful, flexible option to help you build long-term wealth and move closer to your financial goals.

But not all IRAs are created equal. The two most common types—Traditional IRAs and Roth IRAs—offer distinct tax benefits, withdrawal rules, and eligibility requirements. The right choice for you depends on your current financial situation, tax bracket, and long-term retirement goals.

So, how do IRAs work? And more importantly, which one should you choose? Let’s break it down.

What is an IRA?

An Individual Retirement Account (IRA) is a tax-advantaged savings account designed to help individuals set aside money for retirement. Unlike an employer-sponsored plan like a 401(k), an IRA is opened and managed by an individual through a bank, brokerage firm, or financial institution.

How Does an IRA Work?

• You contribute money into the account (subject to annual limits).
• Your investments grow tax-advantaged until retirement.
• Depending on the type of IRA, in general you’ll either get tax benefits now (Traditional IRA) or tax-free withdrawals later (Roth IRA). IRAs provide flexibility in investment choices, allowing account holders to invest in stocks, bonds, mutual funds, ETFs, and more, tailoring their portfolios to fit their risk tolerance and financial goals.
  
  

Traditional IRA vs. Roth IRA: What’s the Difference?

Both Traditional and Roth IRAs serve the same basic purpose: to help you save for retirement with tax advantages. However, they differ in several key areas, including how and when you pay taxes, withdrawal rules, and eligibility requirements.

1. Tax Treatment

• Traditional IRA: Contributions generally are tax-deductible, which can lower your taxable income in the year you contribute. However, withdrawals in retirement are taxed as ordinary income.
• Roth IRA: Contributions are made with after-tax dollars, so you don’t get an upfront tax break—but your withdrawals in retirement (including earnings) are completely tax-free.

2. Withdrawal Rules & Penalties

• Traditional IRA:
  • Required Minimum Distributions (RMDs) begin at age 73.
  • Withdrawals before age 59½ may incur a 10% penalty (unless an exception applies).¹.
• Roth IRA:
  • No mandatory withdrawals during your lifetime.
  • You can withdraw contributions anytime tax-free, but earnings can only be withdrawn tax-free after age 59½, provided the account has been open for at least five years.

3. Contribution Eligibility & Income Limits

• Traditional IRA: Anyone with earned income can contribute, but the ability to take a tax deduction for your contribution phases out at higher incomes, especially if you have a 401(k) or another employer-sponsored plan.
• Roth IRA: Contributions are restricted by income. In 2024, single filers making over $161,000 and married couples earning over $240,000 cannot contribute directly to a Roth IRA.²

4. Future Tax Considerations

• Traditional IRA: Tax savings now, but withdrawals are taxed later at your ordinary income tax rate in retirement.
• Roth IRA: No immediate tax break, but your money grows tax-free, and you won’t owe taxes on withdrawals in retirement.

5. Flexibility & Emergency Access

• Traditional IRA: Some penalty-free withdrawals are allowed for first-time home purchases, qualified education expenses, or hardship withdrawals. However, income tax still applies.
• Roth IRA: You can withdraw your original contributions anytime without penalties or taxes.
  
  

So, Which IRA Is Right for You?

The right choice depends on your current and future financial situation. Here’s a quick breakdown:

A Roth IRA Might Be Better If:

• You expect to be in a higher tax bracket in retirement.
• You want tax-free withdrawals in retirement.
• You don’t want Required Minimum Distributions (RMDs).
• You want more flexibility to access your contributions.

A Traditional IRA Might Be Better If:

• You’re eligible to take a tax deduction now to lower your taxable income.
• You expect to be in a lower tax bracket in retirement.
• You’re not eligible for a Roth IRA due to income limits.
• You have an employer-sponsored plan and want an additional tax-deferred retirement account.
  
  

Both Traditional and Roth IRAs offer valuable tax advantages and can be powerful tools in your retirement strategy. The best choice depends on your personal financial situation, tax planning needs, and long-term goals.

If you're unsure which IRA is right for you, a CommunityAmerica Wealth Advisor can help you navigate the options and create a strategy that puts you on a path to thrive. Schedule a complimentary consultation today.

For specific tax advice, please consult a qualified tax professional.