Dear Young and Focused, I was recently at the library asking the librarian about some financial literacy books. After I was done, someone walked up to me and asked me if I knew if any of the books that I was discussing were particularly good. He said that he was thinking about reading up on IRAs because he was getting ready to open one. I asked had he already had a Roth IRA. He asked me…What is the difference between a Roth IRA and a traditional IRA?
I responded, “Great Question!” But, first I explained to him…
How are a Roth IRA and a Traditional IRA Alike?
- Roth IRAs and traditional IRAs are both retirement accounts.
- In fact, IRA is an abbreviation for Independent Retirement Account.
- They both offer some tax advantages.
- The money grows in both types of account without being taxed.
- Both accounts have a $6500 maximum contribution for 2023, unless you are 50 years old or older, in which case you can contribute up to $7500 a year.
- There is no age limit on making contributions to either type of IRA, as long as you have qualifying contributions.
- There is not minimum amount to start either account. (However, some providers may require minimum amounts to open an account with them. So, be sure to check with the various providers that you are considering.)
- You can start both a traditional IRA and a Roth IRA on your own.
- There are not fees for opening either type of account.
Now….Back to the question that the young man at the library asked me…
What is the Difference Between a Roth IRA and a Traditional IRA?
- In a Roth IRA, you put money into it using money that has already been taxed. In other words, you fund the account with after-tax money
- In a traditional IRA, you can put money in before it is taxed or after it is taxed. So, you can earn money, put some into the traditional IRA before tax, and then the rest of your earnings would be taxed.
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- Traditional IRAs are tax-deferred accounts. This means that you don’t pay tax on the money when you earn it from your active employment. However, you pay tax on the income as you pull the money out during your retirement.
- With a Roth IRA, it is a non-taxable account. This means that as you pull the money out during retirement, you will never have to pay any taxes on that money.
- With a traditional IRA, you will be required at age 72 to make required minimum distributions.
- With a Roth IRA, you will never be required to take the money out. You may leave the money in as long as you want to leave it there. So, there are no required minimum distributions.
- With a Roth IRA, you can take contributions out at any time. But, you must be careful to not take out more than your contributions. In other words, you cannot take out any of your growth. Otherwise, you will receive a penalty. (Note: If you have converted money from a traditional IRA to a Roth IRA, you cannot take money out of that converted Roth IRA without a penalty until 5 years after the conversion.)
- With regard to withdrawals without penalties, in a traditional IRA you cannot make withdrawals until age 59½.
Key Takeaways About The Difference Between Roth IRAs and Traditional IRAs
While there are several similarities between a traditional IRA and a Roth IRA, the differences are as follows:
- A Roth IRA is funded with after-tax dollars. While a traditional IRA can be funded with pre-tax dollars or after-tax dollars.
- Money earned in a Roth IRA is never taxed. Money earned in a traditional IRA is tax-deferred.
- With a Roth IRA, there are no required minimum distributions. With a traditional IRA, required minimum distributions start at age 72.
- With a Roth IRA, you can take contributions (not growth) out at any time without penalties. In a traditional IRA you cannot make withdrawals, without penalties, until age 59½.
So, after discussing the differences between the two types of retirement accounts, the young man said that he would seriously consider a Roth. I suggested that he continue researching his choices and told him that he should also check with a financial advisor, such as a CPA.
I left the library feeling happy that I helped another young person in their search for financial literacy, thanks to that young man at the library.
Thank you to you, too, for reading this. You, too, help me with my goal of spreading financial literacy.
Do you want to learn more about Roth IRAs? Check out:
What is a Roth IRA?
What is the Best Retirement Account?
Do you want to read more about how to build your wealth? Check out:
Earn As Much Interest As Possible
Start Creating Passive Income Today
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Hugs and Keep Building Your Financial Literacy,
Rich Mom
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Also, please note: I am not an investment advisor. Always do your own due diligence and research before investing. Check with your own investment advisor.
The information shared here is not intended as financial advice, just encouragement.