Traditional vs. Roth – One IRA to Rule Them All

by / ⠀Startup Advice / August 24, 2012

My last post on saving money had some interesting comments (Thanks to everyone who reads, Likes, Tweets or comments!) that got me thinking about my next topic. I decided to take a specific topic (retirement accounts) and explore it a little more in-depth. I want to talk specifically about Roth IRA’s and how they can benefit savers and investors.

I want to emphasize that Roth IRA’s are absolutely not for everyone and not even possible for many people. Before you decide to go down the Roth IRA path, first make sure you are eligible and take some time to read through the links at the end of the article. Also, this is a very complex topic

What is a Roth IRA?

As always, for finance related questions, I recommend going to Investopedia. They are a great resource for user-friendly information on complex financial topics. There are two forms of Roth retirement accounts. The Traditional IRA and the Roth IRA.

In a Traditional IRA, your contributions are tax-deductible, but your withdrawals are subject to federal income tax. A Roth IRA is a retirement account which you contribute money after taxes, it is coming out of your disposable income. A good way to think of the difference is that in a Roth IRA you are contributing after-tax money now for the right to avoid taxes on future distributions.

The Roth IRA format is simpler for retirement planning because you don’t need to worry about the tax liability upon withdrawal. Distributions are free of tax and penalty assuming you have held the account long enough (5 years) and are either old enough (59.5) or have a valid reason (disability). You are trading the taxes on today’s money for no taxes on the appreciation.

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According to current tax law, Traditional IRA’s can be converted into Roth IRA’s. This may change at any time, so please do some personal research before making decisions and talk to a professional.

Roth Restrictions

Roth IRA’s have some disadvantages as well. Obviously, the lack of tax deductions at the time of contribution is a significant one. Some restrictions also exist. There is a cap on the annual contribution amount, $5,000 for age 49 and below and $6,000 age 50 and above. For married couples, each spouse may contribute the amount above. Another limit exists on the basis of Modified Adjusted Gross Income (MAGI). This number can be found on your 1040 tax return. The MAGI limit to make the full contribution mentioned above is $110,000 for single filers and $173,000 for joint filers.

What’s Best for You?

Sorry, but I can’t answer that. I have tried to lay out some of the pros and cons, but in the end its up to you to educate yourself financially (its your money). I hope this was helpful as you make decisions about saving for the future. Side note, if you follow the goings on in Washington, you know that any of this could change in the coming months. I believe we should work with the rules in place now and concentrate on developing good habits, let the politicians bicker over the details. I’ve added some resources below for more information and ideas. Let me know what I missed in the comments.

Additional resources for Traditional and Roth IRA information:

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Scott Moorhouse – I am a recent International MBA grad and recovering finance professional. My goal at Under30CEO is to make personal finance more accessible to those without finance or accounting degrees. 

About The Author

Matt Wilson

Matt Wilson is Co-Founder of Under30Experiences, a travel company for young people ages 21-35. He is the original Co-founder of Under30CEO (Acquired 2016). Matt is the Host of the Live Different Podcast and has 50+ Five Star iTunes Ratings on Health, Fitness, Business and Travel. He brings a unique, uncensored approach to his interviews and writing. His work is published on Under30CEO.com, Forbes, Inc. Magazine, Huffington Post, Reuters, and many others. Matt hosts yoga and fitness retreats in his free time and buys all his food from an organic farm in the jungle of Costa Rica where he lives. He is a shareholder of the Green Bay Packers.

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