- Traditional individual retirement accounts, which are funded with pretax money, and Roth IRAs, which are for post-tax money, have different rules for retirement savers.
- IRA expert Ed Slott breaks down what you need to know.
There are dramatic differences between traditional and Roth individual retirement accounts.
And what you don't understand about the particular rules that apply to them can cost you, according to IRA expert Ed Slott, founder of Ed Slott & Co.
With traditional IRAs, you get a tax deduction up front. The taxes you pay on that money are delayed until you withdraw it in retirement.
Roth IRAs, on the other hand, are funded with post-tax money.
"With a traditional IRA, you're at the mercy or uncertainty of what future higher tax rates might do to your retirement savings," Slott said. "With a Roth IRA, you don't have to worry about future rates, because your tax rate in retirement will be zero."
There are five key differences between these two retirement accounts that savers need to understand.
1) Income limits
Contributions to traditional IRAs do not have income limits for savers who contribute to these kinds of accounts (though high earners may not get the upfront tax break).
Roth IRA contributions, however, do have income limits. But Slott noted they are "very high." For 2018, the income phase-out range is $120,000 to $135,000 for singles and $189,000 to $199,000 for married couples who file jointly.
2) Age limits
The rules for traditional IRAs prevent you from making contributions once you turn 70½.
But the same doesn't apply to Roth IRAs. You can continue to contribute to those accounts at any age, according to Slott, if you have the earned income wages or self-employment income to do so.
3) Plan participation
Your participation in a retirement plan generally doesn't affect either traditional or Roth IRA accounts.
It is important to note, however, that with a traditional IRA, you may not be eligible for the deduction depending on your income.
4) Required minimum distributions
The rules around required minimum distributions mark the biggest difference between traditional and Roth IRAs, according to Slott.
With traditional IRAs, you are forced to take distributions starting at age 70½. Roth IRAs aren't subject to required minimum distribution rules.
5) Money withdrawals
If you withdraw from a traditional IRA before retirement, you will pay tax on that money. Plus, if you are under 59½, you generally will be subject to an additional penalty.
Roth IRAs, on the other hand, can be withdrawn from at any time for any reason, penalty free. The key is that those withdrawals have to be the money you contributed, not funds from IRA conversions or earnings on your investment.
"That's a big deal for lots of younger people who are worried, 'What if I need to get to my money?'" Slott said.
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