Roth vs. Traditional IRA – Everything You Need to Know
Investing in a retirement account is a great way to make sure you have extra money when you stop working. Two popular options are Traditional and Roth Individual Retirement Accounts (IRAs). Before you choose an account, it’s important to make sure you qualify and that you know how the contributions and withdrawals for each account are taxed.
How Do Traditional IRAs Work?
With a Traditional IRA, you can contribute either pre-tax or after-tax dollars. Your account grows tax-deferred through the compounding of interest and you pay taxes when you start making withdrawals.
There are no income limits to participate in a traditional IRA. Nearly anyone can open one and invest for retirement. There are annual contribution limits that you should be aware of, however. For 2023, you can contribute up to $6,500 if you’re younger than 50 and $7,500 if you are 50 years or older.
How Do Roth IRAs Work?
Roth IRAs are similar to traditional IRAs in that they are both retirement accounts that can grow over time through the compounding of interest. However, the main difference in Roth IRAs is in how contributions are taxed.
Roth IRA contributions are made with after-tax dollars, which means you have already paid taxes on the money you invest. Therefore when you retire, you do not have to pay additional taxes on the money you withdraw. The contribution limits for Roth IRAs are the same in 2023 as for traditional IRAs.
Unlike traditional IRAs, only those who earn below certain income thresholds can participate in Roth IRAs. Qualification is based on your tax filing status and modified adjusted gross income (MAGI).
You can contribute the full amount to a Roth IRA in 2023 if you meet the following criteria:
- You have a MAGI of less than $138,000 and file as single, head of household, or married filing separately. If you filed married filing separately, you must have lived separately from your spouse during the year.
- You have a MAGI of less than $218,000 and you file as a qualifying widow(er) or file a joint return.
Traditional and Roth IRA Comparison
If you aren’t sure which IRA to go with, the following comparison of traditional and Roth IRAs may help you decide which option is best for your needs.
To qualify for a Roth IRA, you must not earn above a certain amount based on your modified adjusted gross income. To qualify for a Traditional IRA, you must have taxable income or be the non-working spouse of someone with taxable income, and file a joint return.
With a traditional IRA, taxes are paid when you make withdrawals. With a Roth IRA, taxes are already paid on the money you invest and therefore you don’t pay taxes on withdrawals.
The annual contribution limits are the same for both accounts. For 2023, you can contribute up to $6,500 if you are younger than 50 and $7,500 if you are older than 50.
With a Traditional IRA, you can make penalty-free withdrawals at age 59 ½. With a Roth IRA, you can make penalty-free withdrawals at 59 ½ as long as you’ve held the account for at least five years.
Required Minimum Distributions
With a Traditional IRA, you must withdraw the required minimum distributions starting at age 73. With a Roth IRA, there are no required minimum distributions.
Can You Convert a Traditional IRA Into a Roth IRA?
If you have been investing in a traditional IRA but you prefer the benefits of a Roth, it’s possible to convert your account. When you convert from a traditional IRA to a Roth, you’re changing the way the account is taxed.
To complete the conversion, you must pay taxes on the contributions and earnings you have accumulated in your account. This converts the money in the account from pre-tax to after-tax dollars.
To convert your account from a traditional IRA to a Roth, you simply inform the financial institution that manages your account and the bank or credit union will assist you with the conversion.
How to Open an IRA
Establishing an IRA account is very simple. The following steps outline the process:
1. Choose a Provider
It’s important to find a financial institution that charges low account fees and commissions. Also, be sure the bank or credit union offers a variety of investments to choose from and also offers excellent customer support.
2. Open an Account
Depending on the provider, you may be able to open an account either online or in person. You will be required to enter personal details and financial information.
3. Fund Your Account
After your account is established, there are several ways you can fund it. Depending on the bank or credit union, you can fund it with cash, write a check, or transfer funds from your checking or savings accounts.
Choosing Between a Traditional or Roth IRA
For many, deciding whether to go with a traditional or Roth IRA comes down to the tax bracket they think they will be in when they retire.
If you think your taxes will increase when you retire, a Roth IRA allows you to pay taxes on your account while you are in a lower tax bracket. If you think your taxes will decrease when you retire, a traditional IRA will allow you to save money on taxes when you start making withdrawals.
When considering your IRA options, it’s important to keep in mind that the tax code changes every year. It’s impossible to know what the tax brackets will be in the future. Because of this, it’s important to consider all of the pros and cons of each account option before making a decision.
IRAs With Jeanne D’Arc Credit Union
If you’re thinking about opening an IRA account, Jeanne D’Arc Credit Union offers both traditional and Roth IRAs. Unlike other financial institutions, our IRAs don’t have any annual maintenance fees. Getting started is also very easy. You can visit any branch to open an IRA.
Click on the following link to learn more about our traditional and Roth IRAs.