Distinct advantages depending on your needs now and in retirement

When you go to a financial institution to open an Individual Retirement Account (IRA), you’ll have two basic options: Traditional or Roth. There are some similarities between the two, as the maximum contribution that you can make in 2022 is $6,000 total (or $7,000 if you are over 50) between both accounts. But each option offers distinct advantages depending on your needs now and in retirement. Let’s look at those differences.

Traditional IRA

With a traditional IRA, you may be able to deduct your contribution right away and lower your taxes today. That deduction not only lowers your taxes; any returns you earn on the growth of your IRA are not taxed either. However, that doesn’t mean you never pay taxes on the money in your traditional IRA. You pay taxes upon withdrawal, and you must start taking distributions on your IRA once you reach age 70½. Those distributions will be taxed at whatever rate applies to you at the time of distribution. So if you think your tax rate will likely be lower in retirement, a traditional IRA might make sense now and for your future.

Anyone under the age of 70½ with taxable income is eligible to contribute to a traditional IRA, but your contribution may not be tax deductible depending on your income or whether you contribute to a 401(k). And you won’t want to tap into the funds in your IRA before you reach the age of 59½. If you do, you may have to pay taxes on the distribution and an IRS penalty of 10 percent. You can avoid penalties for withdrawals for qualifying reasons, such as a first home purchase or a medical expense, but you will still need to pay taxes on the funds you withdraw.

Roth IRA

You pay taxes on your income at your current tax rate before contributing to a Roth IRA. The money you earn on the account is not taxed, and you can also withdraw the money tax-free in retirement. There’s no age at which you must start withdrawing funds. If you think you’ll be paying a higher tax rate in retirement, a Roth IRA might be a good choice.

Not everyone is eligible for a Roth IRA. High-earning individuals can’t contribute. For instance, single filers must have an income below $129,000 for the full Roth contribution and under $144,000 for a phased-out contribution amount in 2022. Using the money you’ve contributed to a Roth IRA is typically easier than accessing money in a traditional IRA. You can withdraw your contributions to a Roth IRA without penalty, but taxes and penalties may apply if you withdraw earnings on the account.

Make sure you consult a Certified Public Accountant or another accredited tax advisor before making any decisions related to funding your retirement account.