You may be wondering about the difference between a traditional IRA vs. a Roth IRA. The distinction involves the way each investment is taxed. In the case of traditional IRAs, the investor provides “pre-tax” contributions. Roth IRAs, on the other hand, involve “after-tax” contributions. But what does that actually mean for your retirement fund? What are the benefits of a traditional IRA vs a Roth IRA?
At Green Century we offer a wide array of investment vehicles including both Traditional IRAs and Roth IRAs. Learn more about each type of investment and its benefits below.
What are Traditional IRAs?
In a traditional IRA (short for “individual retirement account”), investors receive immediate tax benefit for money they contribute to the account (up to certain limits). This is what we mean when we say traditional IRAs allow for “pre-tax” contributions. The money that flows into traditional IRAs is not subject to taxation at the time it is invested or earned. Instead, you pay tax on the amounts you withdraw from the account at a later date, usually in/for retirement.
The benefits of traditional IRAs accrue from the deferral of taxes. In other words, money that would otherwise go to the government in the form of tax payments up front is instead invested and earns a return. While you do have to pay tax at a later date, your money grows in the meantime.
IRA’s may work well for people who currently find themselves subject to high marginal tax rates: high earners with money left over to save and invest. The immediate tax break can offset what would otherwise be significant taxation.
You should be aware that there are required minimum distributions you must take that begin at age 72. Also, traditional IRAs are subject to maximum contribution amounts that differ depending on your age. If you’re under the age of 50, the maximum annual contribution is currently $7,000, while those over 50 may contribute up to $8,000 per year.
What are Roth IRA Accounts?
In a Roth IRA, investors contribute “after-tax” money to the investment vehicle. In other words, you don’t get an immediate tax deduction or credit for the money you contribute to a Roth IRA. Instead, the benefit of a Roth IRA is that any investment gains in your Roth IRA can be withdrawn at a later date, tax-free.
Roth IRAs are especially useful if you expect your marginal tax rate to be significantly higher at the time you withdraw your investment compared to the time you make your initial contributions. For example, this would be true of people who expect to earn more later in their careers.
In order for your withdrawals to be tax-free, the account must have been open for a minimum of 5 years at the time of your first withdrawal. Additionally, you must be at least 59.5 years old when you make your first withdrawal.
You should also know that there are income limits for those seeking to make use of a Roth IRA. Individuals earning more than $144,000 in the year 2022 – or married couples earning more than $214,000 annually – may not contribute to a Roth IRA.
Open a Traditional IRA or Roth IRA with Green Century
There’s no single right answer for people trying to decide between a traditional IRA vs. a Roth IRA. Each investment vehicle involves a trade-off between pros and cons, as well as immediate and deferred benefits and costs. We strongly suggest you obtain professional advice that takes into account your goals, investment time horizon, and financial situation before deciding in favor of one or the other.
We’re able to answer any questions you may have about the types of accounts we offer at Green Century. Or, if you’re ready to begin saving for your future and your family’s future, we’d be happy to help you open an account.