The Tax Differences Between A Traditional IRA And A Roth IRA

An individual retirement account is an effective vehicle to save for the future while also deferring income tax. The two most widely known types of IRAs are the traditional IRA and the Roth IRA. An individual planning to fund an IRA and defer income tax can benefit from contrasting the differences between a traditional IRA and a Roth IRA.

There are a few similarities between the two account types. You must have earned income to fund either type of account. The annual contribution limit for either type of account for 2015 is generally $5,500. A noteworthy aspect of both IRA types is that you can also fund a separate IRA for a non-working spouse. The main differences in the two account types are in the timing of the tax benefits.

Traditional IRA

In a traditional IRA, you receive a current tax deduction for your contribution, up to the annual limit. The amount contributed to the account grows tax-free until withdrawn. When funds are eventually distributed from the account, the withdrawals are usually fully taxable. As a retiree, you may be in a lower tax bracket at that future time.

Your earned income for the current year must be at least as much as the IRA deduction. The annual contribution limit is the full $5,500 if you are not covered by a retirement plan with your employer. If you are covered by an employer's retirement plan, your deduction for a traditional IRA is reduced at higher income levels.

Roth IRA

In a Roth IRA, there is no tax deduction up front in the current year. As with a traditional IRA, earnings grow tax-free until eventually distributed. The distinct difference of a Roth IRA is that the entire withdrawal is generally tax-free, including the accumulated interest. Participation in an employer retirement plan has no effect on a Roth IRA, but Roth contributions are limited at higher income levels.

If you are age 50 or older, you are allowed to contribute $6,500 to either type of IRA. An additional account of either type can be established for a non-working spouse if the working spouse earns more than the total contributed to both accounts. The IRA for a non-working spouse is a separate account since all IRAs are owned individually.

You are not necessarily limited to one account type, but the annual contribution limit applies to IRA contributions in total. Contact a tax services specialist like RJ. Garner CPA & Associates, PLC) for more information about how individual retirement accounts affect your tax return.