Why Roth Over a Traditional IRA?

IRA accounts represent one of the very best opportunities for individuals to prepare for their future. When people begin looking at them one central question arises. Which is best, one of the traditional IRA accounts or the newer Roth IRA?

Compare a Traditional to a Roth IRA

Many features are essentially the same in all IRA accounts, such as the maximum contributions allowed, so they will not be discussed in this article. Here the focus will be on the differences.

The most apparent and important difference is clearly the tax issue. Traditional IRA’s are funded with pre-tax dollars. This means that the total amount of investment is deducted from income before computing taxes. The Roth IRA, on the other hand, is funded with post tax income. There is no tax advantage at the time of investment.

On the disbursement end, however, the contrast is just the opposite. With the traditional IRA all withdrawals are fully taxable. With the Roth IRA there are no taxes for withdrawals, for either contributions or earnings.

Traditional and Roth IRA Limitations

There are limitations for both forms of the IRA but they vary.

  • Traditional IRA’s allow contributions only until age 70; Roth IRA’s have no cutoff (both require qualifying employment compensation).
  • There are no income limitations for the traditional IRA but there are for the Roth IRA (single filers, $110,000 in 2012; married filing jointly, $173,000).
  • Traditional IRA’s require withdrawal beginning at age 70½ but Roth IRA’s have no withdrawal requirement relative to age.

In addition to allowed withdrawals for specified uses with both types (first home, medical needs, education, etc.), Roth IRA’s permit the penalty free withdrawal of contributions (not earnings) at any time.

Benefits of Choosing a Roth IRA

So which form of the IRA is best? Each individual needs to consider their own circumstances and make a decision based on their own financial planning.

However, in my judgment the Roth IRA benefits greatly outweigh those of the traditional IRA for most investors. The reason is simple. The tax benefits are by far the most important distinctions between the two. And for most people the potential tax savings are much greater with the Roth IRA.

Nothing causes people to make bad economic decisions more than short sightedness. It is easy to focus on the small amount of savings that occur when the traditional IRA investments are made because they are immediate. It is harder to imagine that after a few years the Roth IRA would be producing income many times that amount year after year.

In addition, while it is rarely a good idea to withdraw money from retirement investments, the fact that contributions can be withdrawn from a Roth Ira at any time without penalty in contrast with the traditional IRA means that the Roth IRA offers a great safety valve in case of an unexpected emergency not available with the traditional IRA.