What’s the Difference Between a Roth IRA and a Traditional IRA?

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Are you currently investing for your retirement? Perhaps you have a company 401(k) or 403(b), or maybe you’ve been able to invest in a Roth IRA. We all know that we’re supposed to be investing in our future, so we either take a look at what our company provides or what our friends suggest, but most of us really don’t do the research to find out what all of these retirement accounts are all about. At this moment, could you tell me the difference between a Roth IRA and a Traditional IRA?

The Traditional IRA

The 401(k), 403(b), and the Traditional IRA are basically all the same. Sometimes the maximum contributions vary, but these funds are all invested with pre-tax dollars. In other words, your contributions into this fund are not taxed by the state or federal governments. They are inserted into the fund and will be taxed when you remove the money in your retirement years.

The Roth IRA

This retirement account varies greatly from the others. Instead of paying the tax in your retirement years, the tax is paid before it’s even deposited into the account. Also, this account is often more flexible when it comes to removing money – there are instances where you can withdraw money early, and also, many of the accounts allow you to keep your money in the fund for as long as you want, rather than the typical forced withdraw at age 70 1/2 in the Traditional IRA. It is a more personal approach to pensions, similar to a SIPP pension scheme in the UK.

The chart pretty much says it all, but for those of you that like to see the numbers, here you go!

As you can see between the table and the graph, it absolutely does not matter whether you invest in a Roth IRA or a Traditional IRA. As long as the tax rate stays the same between now and your retirement years, your investment dollars will come out looking exactly the same!

Where are you currently investing your money for retirement? Do you wish that you had money in a different type of account?

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Money Retirement

Derek

AUTHOR Derek

My name is Derek, and I have my Bachelors Degree in Finance from Grand Valley State University. After graduation, I was not able to find a job that fully utilized my degree, but I still had a passion for Finance! So, I decided to focus my passion in the stock market. I studied Cash Flows, Balance Sheets, and Income Statements, put some money into the market and saw a good return on my investment. As satisfying as this was, I still felt that something was missing. I have a passion for Finance, but I also have a passion for people. If you have a willingness to learn, I will continue to teach.

33 Comments

    • It is some good information to know for sure! I’m glad that you learned it long ago.

  1. The graph summed it up nicely for me – we were talked into opening Roth’s from our insurance agent a few years ago. We just said sure, we had no idea why or why not. After a little asking around, we decided to stick with both the Roth and the 401s.
    Deanna Koch recently posted..Roku Update

    • I’m glad the graph helped! I know visuals help me understand financial theories, so I decided to throw a graph and a table into this article, just to make sure the point was clear. Thanks for the comment!

  2. Currently I’m contributing to a roth 401k at work and my matching dollars are in a regular 401k. I figure this gives me some diversification so that when I retire I can pull out a little from both to try to minimize my tax burden.

    Also I’ve chosen the roth 401k because I’m young, expect my earnings to increase over the years and expect tax rates to raise. As those things happen I will make the switch over to the regular 401k when I feel the time is right.
    My Money Talk Online recently posted..Why I Love Dividend Growth Stocks

    • Yep, if you think that taxes will increase in the future, then a Roth IRA the way to go. Great choice!

  3. If you are already maxing out the government numbers in your 401k, my understanding you can’t do the traditional IRA’s, but you can still do the Roth’s?

    • Nancy, as I understand it the maximum limit for the IRA pertains to both the traditional and the Roth. In other words, if you max out one, you can’t contribute to the other one. Or, you could contribute half of the maximum to both. If, however, you maxed out a 401(k), I’m fairly certain that you could still contribute the maximum to a Roth IRA. Hope that helped!

  4. The balance in my 401k is double that of my Roth but only because of the contribution limit. Its hard to know what’s better. With the national debt so high, the only.way we will get free will be to raise taxes but one cant be certain. I’m preparing for 50% tax rates by the time you and I retire. We ll see…..
    funancials recently posted..February Blog Earnings and Update

    • If we have 50% tax increases, I think I may be moving to another country!!!

  5. “As you can see between the table and the graph, it absolutely does not matter whether you invest in a Roth IRA or a Traditional IRA.”

    – While your assertion that both are better than one or the other I agree with, this sentence is incorrect, Derek. You’ve identified the crossover point between the Roth IRA and the Traditional IRA. Longer term savers will have more money in a Roth IRA, while shorter term savers will have more money in a Traditional IRA with the tax write-off (non-deductible Traditional IRAs always lose…).

    The lynch-pin, though, is your statement that “assuming tax rates stay the same.” Because they never do, I believe a flexible plan using both is better than a one-or-the-other approach.
    AverageJoe recently posted..Cuppa Joe: Ignoring Good Advice and Paying For It

    • Tax write-offs are not included in this comparison Joe, since the tax laws are always changing as well. As for the tax rates, will they go up, or will they go down? Nobody really knows. If the tax rates go down, the Traditional IRAs will win. If they go up, the Roth IRA will win. Either way, there’s a gamble.

      • I agree totally (I just reread what I wrote last night in the last paragraph, and it should have said, “where I agree with you is….”). Definitely, because it’s a gamble it’s better to do both.

        Here’s why I said you found the crossover point: in later years using your criteria above, the Roth IRA clearly wins: http://www.moneychimp.com/articles/rothira/rothcalc.htm In early years, depending on the amount of pre-tax IRA money you start with, the Traditional IRA often wins.

        Most calculators say that a traditional IRA is better for short term goals and a Roth IRA is better for long term savers.

        Forget the math, though…I’m with you…both is a better strategy because (as you said above) it’s a gamble.
        averagejoe recently posted..Cuppa Joe: Ignoring Good Advice and Paying For It

        • You’ve got it! Thanks for the comment, I’m sure it was a benefit for a lot of people!

    • No problem! I’m always glad to help people out with some good info!

  6. I’ve got money in a Roth and 401k. I’m with extra money coming in I’m hesitant to put more into retirements accounts because I plan on retiring early and will need to bridge the gap between early retirement and age 59 1/2.

    I will open up a taxable brokerage account next vs maxing out my 401k.

    • all kinds of fail with my post. its too early, i need my coffee. Below is the same post minus grammar mistakes.

      I’ve got money in a Roth and 401k. *With extra money coming in I’m hesitant to put more into retirement* accounts because I plan on retiring early and will need to bridge the gap between early retirement and age 59 1/2.

      I will open up a taxable brokerage account next vs maxing out my 401k.

      • I’m with you on this Matt. I’m not loading all of my extra money into retirement accounts because I’ll most likely retire early. I’ll have a paid-for house in a few years, and then I think I’ll have some real estate investments – that will provide me some cashflow as well as some equity in the event that I ever want a wad of cash. 😉

    • No problem Tricia! Glad you enjoyed it!

    • Sounds like an excellent plan! Thanks for commenting Chuck!

    • Sounds like you’ve got a good plan as well. I’ve got such responsible readers – it’s great!

  7. Based on how politics has been going, I’m actually doubtful that there will be much of an income tax in the future. Both parties have been eying different tax schemes in the future whether it’s a carbon tax, VAT or national sales tax. The income tax is too hard to move up politically so I think it will continue to move down; at least for middle class wage earners.
    Wayne @ Young Family Finance recently posted..What to Invest in?

    • That’s my viewpoint as well Wayne, that’s why, when I reviewed my company 401(k), I decided that it would just be simpler to keep it as a traditional account, rather than transform it into a 2nd account for the Roth. With my extra income from this site, I’ll most likely set up a Roth on the side anyway. Thanks for the comment!

  8. I just wish my employer offered matching contributions in the 401(k) program.

    • That really would make a huge difference. Don’t let it stop you from contributing though! 🙂

  9. But ROTHs effectively allow you to get more money into a tax shelter because the $5000 binds on post-tax money (i.e. sure, things are equivalent if you put $5k in a trad IRA and 3.75k in a roth IRA, but you can put extra money into the roth and get additional tax shelter benefits).

    • That is a valid point Money Man. Thanks for the comment!

  10. I’m not sure if I ever asked this or not; I currently max out how much I can put in my 401k. I think I can still do roths in addition to that? If yes, what is the best mechanism for doing so – I don’t have a brokerage firm or anything like that, how do you go about participating in a roth? Showing my ignorance…


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