Do you know the difference between a Traditional and a Roth IRA? If not, it’s time to learn.

The biggest difference between the two is when you pay Uncle Sam the taxes you owe. For a Traditional IRA, your contributions to the account may be tax deductible. In other words, you get your tax break now. You will pay taxes on that money when you take it out in retirement. However, for a Roth IRA, you pay into it with post-tax (a.k.a. after-tax) dollars. What’s great about a Roth is that it grows tax free and you don’t pay taxes on it when you withdraw the funds in retirement.

There are government rules for both so I’ll touch on those. Anyone who earns and income can create and contribute to a Traditional IRA. Unfortunately, your deduction limits may phase out at higher income levels when you’re enrolled in a workplace retirement plan such as a 401(k). For a Roth IRA, income limits apply.

When you retire, and your ready to withdraw your funds, with a Traditional IRA, you’ll have to pay taxes on the money you withdraw. And, if you’re younger than 59 ½, you may incur a penalty along with the taxes you owe. If you’re aged 73 (current rule), you must withdraw a certain amount of your funds and take taxes out. This is called Required Minimum Distributions (RMDs). With a Roth IRA, the story is much different. Contributions into your Roth can be withdrawn at any time, for any reason, without taxes or penalties. The earnings can be withdrawn after age 59 ½ without taxes as long as the account has been open for 5 or more years.

Moral of the story:

The biggest difference between a Traditional and a Roth IRA comes down to taxes. Do you want your tax deduction now? Do you expect to be in a lower tax bracket when you retire? Or do you need to decrease your taxable income this year? If so, use a Traditional IRA. On the other hand, do you prefer tax-free income later? Do you anticipate your taxes will go up in the future? Or do you value the flexibility of being able to withdraw your contributions, then definitely use a Roth IRA. Please check the rules with the IRS so that you have the most up to date information.