Traditional IRAs Traditional Individual Retirement Accounts (IRAs) are tax-deferred, meaning you don’t have to pay taxes on interest or other gains the account makes until you withdraw the money. The contributions you make to the account can entitle you to a tax deduction every year. Calculating your IRA contributions as tax deductions depends on the type of IRA you invest in, the retirement savings your employer offers, and your income. Roth IRA income can be withdrawn tax-free from the age of 59 if you have managed the account for at least five years.
If you make a distribution of Roth IRA earnings before you are 59½ years old and before the account is five years old, the income may be taxable and subject to a 10% federal tax penalty. Beneficiaries of Roth IRAs also do not owe income tax on withdrawals, but must make distributions or include the account in their own IRA. You can contribute to both a traditional IRA and a Roth IRA as long as you meet specific requirements. A key decision point when choosing between a traditional IRA and a Roth IRA is whether you prefer a potential tax break now or later.
In fact, you need to determine whether the tax rate you pay today on your Roth IRA contributions is higher or lower than the tax rate you’ll pay later on distributions from your traditional IRA.