What’s the difference between the two types of IRAs? And what is similar?
You probably know a little bit about this subject – like one IRA is deductible on your income taxes, and the other one has some kind of tax benefit… but the differences are hard to understand, and can be even harder to explain. Below are the major differences between the two, followed by the similarities. This discussion is liable to be useful as you consider which kind of IRA is best for you (and both could be best for you, at different times in your life).
Differences Between Traditional IRA and Roth IRA
Deductibility is a feature of the Traditional IRA (Trad) that is not available in the Roth IRA (Roth). What this means is that, subject to the limits we discussed here, you may be able to deduct the amount of your contribution to your Trad from your Gross Income in the year of the contribution. When the Traditional IRA was originally introduced in 1974, the deductibility feature was not included. This was added in 1986, and is one of the primary reasons that Trads have remained as popular as they are to this day. At the time of the introduction of the deductibility feature, very few companies offered 401(k) plans so the Trad offered one of the only tax shelters available to nearly every taxpayer.
Tax treament is another major difference between the two kinds of IRA. The Trad’s distributions are always taxable (if not rollover distributions) as ordinary income, while the Roth’s distributions are always tax-free (as long as they meet the requirements, such as after age 59½). What is also very different about the two is that your contributions to a Roth are always available for withdrawal at any time for any reason – tax free. The growth in the Roth (interest, dividends, capital gains) would be taxed and subject to penalty if withdrawn for an ineligible reason, though. The Trad does not have such a provision.