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

 

Source: Thinkstock

Source: Thinkstock

Saving for retirement is a major obstacle for Americans. A 401(k) plan is the most common vehicle to place money aside for employees who are fortunate enough to do so, but what about the millions of people who don’t have access to a plan through their employer? An individual retirement account (IRA) may be the best option for these workers. There are two main types of IRAs: Traditional and Roth. Both are designed to help you save for retirement. However, there are some key differences between the two.

Tax Benefits

A Traditional IRA experiences tax-deferred growth, which means you contribute pre-tax dollars and pay ordinary income taxes when you make withdrawals in retirement. Depending on your income and if your spouse is already covered by a retirement plan at work, your contributions may also be tax-deductible.

A Roth IRA grows tax-free, meaning you contribute dollars after Uncle Sam takes his cut, and you won’t pay taxes on withdrawals as long as you take them after you have reached age 59 1/2 and owned the account for at least five years. A Roth IRA is generally recommended for younger savers or people who believe their tax responsibilities will be greater at retirement.

Income Limits

A Traditional IRA has no income limits. A Roth IRA has income limits (modified adjusted gross income). As the chart below shows, there are different limits to consider for 2015, depending on your filing status.

Source: IRS

Source: IRS

These limits are reviewed on a yearly basis by the Internal Revenue Service to account for inflation, so it’s important to check for updates. For tax year 2015, the IRS made the following changes to the Roth IRA income limits.

“The AGI phase-out range for taxpayers making contributions to a Roth IRA is $183,000 to $193,000 for married couples filing jointly, up from $181,000 to $191,000 in 2014. For singles and heads of household, the income phase-out range is $116,000 to $131,000, up from $114,000 to $129,000. For a married individual filing a separate return, the phase-out range is not subject to an annual cost-of-living adjustment and remains $0 to $10,000.”