Traditional IRA vs Roth IRA

(Can You Say ‘Taxes?’)

Traditional IRA vs Roth IRA

Tax-deductible contributions or Not tax-deductible

(Don’t worry if tax-talk confuses you. I’ll explain it so a 3rd grader can understand.)

In a Traditional IRA, the contributions are tax-deductible. (Remember, a ‘contribution’ is when you add money to your IRA.)

  • Whatever amount you add to your IRA you’re able to subtract from your taxable income.
  • Subtracting things from your income makes your income lower.
  • The amount of tax you pay is a percentage of your income.
  • The lower your income, the lower amount of taxes you have to pay. (20% of $5,000 is less than 20% of $100,000)

In a Roth IRA, the contributions are NOT tax-deductible. You can contribute your heart out to your Roth IRA, and the contributions will never be subtracted from your taxable income. Sorry. (But there are amazing benefits of Roth IRAs.)

Traditional IRA vs Roth IRA

Distributions are taxable or Tax-free distributions

In a Traditional IRA, distributions are taxable. (Remember, a ‘distribution’ is when you take money out of your IRA.)

Let’s say you’re 60 years old, you’ve retired from work, and you have $5,000,000 in your Traditional IRA (wow, look at all those zeroes!). You would like to take $100,000 and back-pack around Europe for a year or two. So you call your bank or broker, request the distribution, and it’s processed.

Congratulations, you’ve just created a ‘taxable event.’ You now officially owe Uncle Sam a nice chunk of your $100,000. (But you’re going to Europe, so who cares?)

In a Roth IRA, distributions are tax-free. Hey, get off that table and put your shirt back on! Before you get too excited, you should know that this is subject to certain conditions. The conditions are pretty easy to meet, and then all of your distributions are tax-free.

Alright, resume your table dance.

Those are two of the biggest differences of Traditional IRA vs Roth IRA.

  • In a Traditional, you get a nice tax-break right now, today. If you currently have a huge tax bill, and it would be nice to get a break, then Traditional may make sense for you.
  • In a Roth, you get a reallly nice tax-break in the future. If you currently have a low (or no) tax bill, then a Roth probably makes sense for you.
  • Remember, you can have both, too!

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