The Differences between a Roth and Traditional IRA

Roth IRAOften the term Roth IRA is heard on television and mentioned in newspaper and magazine articles, but what is a Roth IRA? If you are familiar with a basic individual retirement account, then a traditional Roth IRA is easy to understand. Although there are several differences between a regular IRA and the Roth IRA rules, the key difference is how the money is taxed when contributions are made and how the withdrawals in retirement are taxed.

When you open a traditional individual retirement account, you will be able to take a tax deduction for your contributions up to a legal maximum. The downside to this is that when you reach retirement age, you will be taxed as you withdraw the money. A Roth IRA flips this upside down. When you contribute to your account, you do not get a deduction for it on your income tax; however, when you retire and begin to withdraw these funds, they are tax free.

An individual retirement arrangement that includes a Roth IRA is usually for those that will have a larger than average income in retirement. Having a tax free source of income is attractive. Many people will have a much lower income in retirement than during their working years. This will mean being in a lower tax bracket, so even with a taxable retirement source, it often makes financial sense to take the tax credit today and be taxed at a lower rate in your retirement years.

Because a Roth IRA does not provide a tax credit for the individual, there is no penalty for early withdrawal in the same way there is with a traditional IRA, and another important element of the Roth IRA. A Roth IRA contribution limit is the same as it is with a traditional IRA. For the year 2013, it is$5,500 or $6500 if you are 50 years of age or older.

A Roth account can be tricky when you attempt a 401k to Roth IRA rollover and can result in owing taxes, so you should consult an accountant. If you have a self-directed IRA, you will be able to choose your own investment vehicles. Many people decide to invest in certificates of deposits, and the best IRA CD rates can be found by comparing both interest rates and the time of the CD. There is enough of a range in offerings that it pays to look at several CDs from four or five financial institutions.

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