Ariel Investments - Traditional vs. Roth IRAs

Previously, I gave a brief review of some retirement accounts. Today I thought I would dig a little deeper into the differences between Traditional and Roth IRAs.

As you may recall, when you hear IRAs, think “Individual Retirement Accounts”. These are wonderful retirement tools because they allow for your investments to grow tax deferred. However, as their name suggests, you need to keep in mind these accounts are specifically meant for retirement purposes – so if you pull your money from these accounts BEFORE you turn 59 ½ years old, you will have to pay a 10% penalty as well as taxes on your earnings. Now to some differences.

When you invest in a Traditional IRA, your earnings grow tax deferred until you access the account after 59 ½. At that time, any earnings are considered income – and therefore is subject to taxes. Now Roth IRAs also allow your investments to grow tax deferred. However, when you access these accounts after 59 ½, your earnings are tax-free. So why would anyone consider Traditional IRAs?

First, some individuals don’t qualify for Roth IRAs. For 2010, if you file your taxes as an individual and your adjusted gross income is above, $116,000 you do not qualify; if you are a married couple filing jointly, your adjusted gross income must remain below $169,000 to qualify. As you may have guessed, Traditional IRAs do not have this income cap, so everyone under the age of 70½ with earned income may contribute.

Another reason some may choose a Traditional IRA is for a tax deduction. Unlike Roth IRAs, contributions into a Traditional IRA may be eligible for a tax deduction. This depends on each individual situation, but can be useful if you’re looking to lower your taxes. As always, check with your favorite licensed tax advisor.

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