Know the differences between Roth and traditional IRAs

If you’re in the early stages of your career, you might not be thinking that much about retirement. That day will arrive eventually, and the sooner you start saving and investing for it, the better.

You may have a 401(k) or similar retirement plan through your employer, but you may also be eligible to contribute to a traditional or Roth (IRA). There are important differences between a traditional IRA and a Roth IRA. You may want to choose one over the other or go with both. Tax-related decisions may impact your IRA choice as well.

What is an IRA?

An individual retirement account (IRA) can be a great way to save for your future. But how do you know which type is right for you? Traditional IRAs and Roth IRAs allow you to contribute up to $6,000 a year, plus an additional $1,000 catch-up contribution each year if you’re 50 or older. The key difference is whether you pay taxes on your savings today or in the future.

What is a Roth?

With Roth accounts, you won’t receive any tax deductions today but can generally take withdrawals in retirement without paying taxes.¹ You may benefit from a Roth IRA if you’re young, currently in a lower tax bracket or have most of your investments in traditional IRA accounts or retirement plans and are looking to increase tax diversification and flexibility in retirement.

What is a traditional IRA?

With traditional IRAs, you may be eligible to take a tax deduction today and delay paying taxes on withdrawals until later, when you begin taking them. This option might make sense if you’re in a higher tax bracket today than you expect to be in retirement.

Traditional vs. Roth comparison

Which IRA should you pick?

Let’s look at the decision process of Jane, a hypothetical “30-something” worker.

Jane has a promising career and is confident her income will increase over time. She was initially leaning toward a traditional IRA because of the potential tax deduction. But after thinking more closely about the choice, two points occur to her.

1. Today's income rates are low, so it's quite possible, perhaps even likely, that rates will be higher when Jane retires, making the taxable withdrawals from a traditional IRA more costly.
2. The RMDs from a traditional IRA may be enough to push her into a higher tax bracket.

Given these factors, Jane decides to contribute to a Roth IRA. 

Of course, other factors can come into play and your situation may be different from Jane’s, so you might reach a different conclusion regarding your IRA. (Also, if your income exceeds certain limits, you’ll lose eligibility for a Roth IRA.) But regardless of which IRA you choose, you’ll be helping yourself greatly by contributing early and often.

How we can help

Talk to your Edward Jones financial advisor today to discuss which type of IRA may be right for you.