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Should I Choose a Traditional or Roth IRA?

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Question: Should I Choose a Traditional or Roth IRA?
Answer:

It can be difficult to choose between a traditional vs. Roth IRA. You may be wondering which type of IRA that you should open. There are advantages to both types of IRAs. There are also disadvantages to both types of IRAs. The biggest factor you will need to consider is how you want to pay taxes on your the money you invest in your IRA.

Advantages of a Traditional IRA

  • Contributions are tax-free
  • Lowers taxable income
  • Earnings grow tax-free, but they are taxed when you withdraw the money
  • Protects money for retirement by having early withdrawal penalties

Disadvantages of Traditional IRA

  • Withdrawals are taxed
  • Contribution limit of $5000.00 a year

Advantages of Roth IRA

  • Withdrawals are tax-free
  • Earnings grow tax-free and are not taxed when you withdraw the money
  • Protects money for retirement by having early withdrawal penalties

Disadvantages of Roth IRA

  • Contributions are made with after tax dollars
  • Does not lower your taxable income
  • Contribution limit of $5000.00 a year

The easiest answer is to simply look at which one you will have to pay the most taxes on. For a Roth IRA, you will only have to pay taxes on your contributions. When you make withdrawals you will not be taxed on the earnings. However if you open a traditional IRA, you will have to pay taxes on the money when you make a withdrawal. This means that you will have to pay taxes on your earnings, which will be a greater amount than your contributions.

You should talk to your accountant or financial advisor to make sure that this choice really is the right one for you. If you feel you need the tax deduction consider looking for other deductions or other ways to lower your taxable income. It is important to take a long-term view when you consider the best IRA to open. Bank IRAs offer security while investment firm IRAs offer the chance for more growth.

If you are trying to roll your 401(k) into an IRA, you may choose to keep it in the same type of account. Some companies only offer traditional 401(k)s. If you were to switch it to a Roth IRA, you will need to pay the taxes on the entire amount you are rolling over immediately. If you have the cash on hand, it can save you a lot in taxes in the future, but if you don't it may be easier to just roll it into a traditional IRA. When you are rolling a 401(k) over, what you are rolling over does not count against your contribution limits.

When you open your IRA, you should choose an investing firm over a bank. The investing firm will allow you to invest in mutual funds or stocks. These options offer more potential growth for your investment, then you would get if you opened the IRA with CDs. When you are in your twenties, you have time to ride out the market, and you should invest more aggressively. Your financial planner can help you find mutual funds that would be a good fit your IRA account.

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