A: Both types of IRAs provide the potential for tax-beneficial growth that can give your retirement savings an extra boost. The key difference between the two is the way your contributions and withdrawals are taxed.
Because all or a part of the money you contribute to a traditional IRA can be tax-deductible if your modified adjusted gross income is below a certain amount, using this type of IRA could help you lower your current tax bill. You'll only have to pay taxes on all or a part of your contributions and any earnings when you begin to withdraw them in retirement.
Contributions to a Roth IRA, on the other hand, are not tax-deductible—but you see a benefit later on, because you won't have to pay federal taxes on qualified withdrawals.1 No matter which IRA you choose, you typically have until the tax return filing deadline to make your contribution for the previous tax year.
Because of the tax differences, a traditional IRA is usually considered more advantageous for people who expect to be in a lower tax bracket in retirement. A Roth IRA might be better for you if you anticipate that your tax bracket will be higher when you retire. If there's a chance you may need to tap into your IRA before you're age 59½, you're also probably better off with a Roth IRA, because your contributions to a Roth IRA can be withdrawn at any time without taxes due. (At the same time, any earnings on your contributions are only tax-free when a qualified withdrawal is taken, unless an exception applies.). With a traditional IRA, if you withdraw funds before you reach age 59½, those withdrawals will be subject to a 10% additional early withdrawal tax, unless an exception applies.
No matter which IRA you choose, you typically have until the tax return filing deadline of each year to make your contribution for the previous tax year.
Another big difference between the two is that with a traditional IRA, you're required to start taking withdrawals at age 70½. With a Roth IRA, there are no withdrawal requirements for the original account owner, so if you're planning to use your IRA as another way to keep on investing for your heirs, a Roth IRA may be the better choice for you. (Your heirs, however, will have to take distributions upon inheriting your Roth IRA.)
There are also a whole slew of rules, regulations and limitations that have to be considered. For instance, you're no longer eligible to contribute to a traditional IRA if you're at least 70½ and you can only contribute to a Roth IRA for tax year 2017 if your modified adjusted gross income is $133,000 or less ($196,000 or less for married couples filing jointly). For tax year 2018, you may contribute to a Roth IRA if your modified adjusted gross income is $135,000 or less ($199,000 or less for married couples filing jointly). Because of all the wrinkles, it's best to check with your financial advisor and your tax specialist before making your decision. They can walk you through all the considerations that apply to your situation.
3 Questions to Ask Your Advisor
- How do I know if I'm contributing enough for retirement?
- Which type of IRA is best if I plan to take withdrawals to put a down payment on a home or pay for college?
- Which might be better to leave for my heirs—a Roth IRA or a traditional IRA?
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1 For a distribution from a Roth IRA to be federal (and possibly state) income tax-free, it must be qualified. A qualified distribution from your Roth IRA may be made after a five-year waiting period has been satisfied (this period begins January 1 of the tax year of the first contribution or the year of conversion to any Roth IRA) and you (i) are age 59½ or older, (ii) are disabled, (iii) qualify for a special-purpose distribution such as the purchase of a first home (lifetime limit of $10,000), or (iv) are deceased. If you receive a non-qualified distribution from your Roth IRA, such distribution generally will be subject to ordinary income tax, plus a 10% additional federal tax if received before age 59½ unless an exception applies.
Neither Merrill Lynch nor any of its affiliates or financial advisors provide legal, tax or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.
You generally have until April 15 of each year to make your contribution for the previous year. If April 15 falls on a weekend or a holiday, the deadline is typically the next business day.