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When planning for retirement, many people turn to individual retirement accounts (IRAs) as a means of saving and investing for their future. Two of the most common types of IRAs are traditional IRAs and Roth IRAs. While both offer tax advantages, there are significant differences in how they operate that make one more appropriate for certain individuals than the other.

Traditional IRAs

A traditional IRA is a retirement savings account that allows investors to make contributions on a tax-deferred basis. This means that investors can deduct contributions from their taxable income in the year that they are made, lowering their tax bill in the short term. Additionally, any earnings that are generated within the account are not subject to taxes until they are withdrawn, typically in retirement when most people are in a lower tax bracket.

There are, however, certain limitations to traditional IRAs. For one, there are yearly contribution limits, which currently stand at $6,000 per year (with an additional $1,000 catch-up contribution for those over the age of 50). Additionally, traditional IRAs require account holders to begin taking required minimum distributions (RMDs) at age 72, which means that they are subject to paying taxes on their distributions at that time, regardless of whether or not they actually need the money.

Roth IRAs

Roth IRAs, on the other hand, function quite differently. Contributions are made on an after-tax basis, which means that account holders are not able to deduct them from their taxable income. This can be a disadvantage in the short term, as it means that contributions are made with already-taxed dollars. However, the benefit of this is that earnings generated in the account are not subject to taxes, ever. Additionally, account holders are not required to take RMDs at any point, which means that they are able to grow their nest egg for as long as they choose.

There are, again, limitations to Roth IRAs. The yearly contribution limit is the same as traditional IRAs at $6,000 per year (with the same catch-up contribution for those over 50). Additionally, there are income limits to be aware of; single filers making over $139,000 per year and joint filers making over $206,000 per year are not eligible to contribute to a Roth IRA.

Which IRA is the right choice?

Ultimately, the decision between a traditional IRA and a Roth IRA depends on a person’s individual financial situation and goals. For those who are in a lower tax bracket now than they expect to be in the future, a traditional IRA may make more sense. For those who anticipate being in a higher tax bracket down the line, a Roth IRA may be a better choice.

Additionally, for those who want more flexibility in how and when they use their retirement savings, a Roth IRA may be preferable due to the absence of RMDs. For those who want a tax break now and do not mind having a mandatory distribution schedule, a traditional IRA may be more appropriate.

In summary, the main difference between traditional and Roth IRAs is the timing of taxes. Traditional IRAs allow for tax-deferred contributions and earnings that are taxed upon distribution, while Roth IRAs require contributions to be made with after-tax dollars but offer tax-free withdrawals in retirement. Understanding these differences is key when determining which type of IRA is the right fit for one’s financial goals and retirement planning.