For those who are putting away funds for their eventual retirement, the IRA — or Individual Retirement Account — is one of the most popular and beneficial options. If you’re considering opening an IRA, you typically have two broad choices: A traditional IRA versus what’s known as a Roth IRA. 

At Jacobsen Capital Advisors, we’re happy to help with a huge range of retirement planning services, including setting up and monitoring vital IRA accounts to help you build your funds up. We’ve helped numerous clients choose between traditional IRA and Roth options, and we even have some clients who utilize both. What are each of these, how do they differ, and which might be best for your needs? Here’s a primer.

Defining Traditional and Roth IRAs

First and foremost, let’s lay out the basics on both these accounts, plus on the IRA account in general. IRAs were created by the US government with the goal of giving Americans a way to put away funds for retirement without having to pay taxes on the withdrawals when they took place. These are long-term retirement accounts in nearly every case — most have a penalty if you attempt to access the funds before you reach retirement age.

Both the traditional and Roth IRA come with a contribution limit of $6,000 for the years 2020 and 2021. However, if you’re over 50 years old, your limits are $7,000 and $6,500 respectively — these numbers rise with inflation each year.

Generally speaking, contribution deadlines for both IRA types will mirror the deadline to file your tax return, meaning you can contribute to the IRA up until tax day of the following year.

In all cases, you have to have earned income from a job in order to contribute to an IRA, and your contribution is limited based on your annual earnings as well as your age. In addition, both traditional and Roth IRAs mandate a “Minimum Required Distribution” each year — this is done so even if you don’t need the money, and it’s a way of ensuring the government gets some tax revenue from these accounts.

Tax Differences

One of the key areas of difference between traditional and Roth IRAs is the way taxes work. Traditional IRA contributions are made with pre-tax income — you don’t pay taxes on this money until you withdraw it. When you do take money out, though, you’ll not only be taxed at your normal rate for that income bracket (unless the IRA is structured as a Roth), but you may also be charged an additional 10% penalty fee if you’re under 59 1/2 years old.

Roth contributions, on the other hand, take after-tax income and thus you’re not taxed on the withdrawals. This is a common reason for individuals to prefer the Roth IRA, but it’s not the only one — there are other differences which could make either option better, including which tax bracket you’re in (many in higher brackets prefer the traditional IRA despite the tax considerations).

For more on traditional versus Roth IRAs, or to learn about any of our retirement planning, investment management or other financial advisory services, speak to the staff at Jacobsen Capital Advisors today.