Differences Between Traditional IRAs and Roth IRAs 2011, 2012

As you plan and invest your retirement savings, you probably have several choices of vehicles you can use – 401K if you’re an employee of a large company, SEP plans for self-employed people, and for most of us, IRAs and Roth IRAs. If you're wondering what the differences between the traditional and Roth IRAs are, then you've come to the right place.

For the most part, IRAs are treated like 401K’s and SEPs in that the money you put into the plan is exempt from taxes when it is invested, but you do pay tax on it whenever it is withdrawn. Since the tax is deferred until you withdraw, these are typically referred as tax deferral vehicles for retirement.

With an Traditional IRA, you must leave the money invested in the IRA until you reach the age of 59 ½ or face a 10% early withdrawal penalty on top of the tax, and you must begin taking a minimum distribution each year from an IRA at the age of 70 ½ .

There are limits to the amount you can make contributions that are exempt from taxes in any year. For 2011, this limit is $5,000 for taxpayers under the age of 50, and $6,000 for those who are over 50. It is usually unwise to contribute more than this to an IRA as excess contributions made in after tax dollars, and they will also be taxed on withdrawal.

The Roth IRA works just the opposite. Contributions to a Roth IRA are always made in after tax dollars, that is, the contributed amount is not exempt from tax. However, provided the appreciation in the account is not taken before the age of 59 ½ , none of the amount withdrawn is ever taxed. Thus, if you invest $5,000 in a Roth IRA for 20 years ($100,000 total), until age 60, and it grows to $500,000 during that time, under the law, you will never pay tax on the withdrawals from this account.

Differences between traditional and Roth IRAs mainly concerns when the income is taxed. The money will be taxed upon deposit or withdrawl. Of course you must always read the fine print and adhere to all the stipulations when it comes to tax laws about finances. Online tax preparation software programs can help you stay current on the lates tax information concerning traditional and Roth IRA accounts.

One thing that has always concerned me with respect to Roth IRAs is that a day may come when Congress decides this is too much of a sweetheart deal and begins to tax “excess withdrawals” or withdrawals made by “the wealthy”. Obviously, if you’re investing in a Roth, you’re hoping it will grow as much as possible and that you become wealthy yourself. So look out – it hasn’t happened yet, but there are no guarantees that any tax break will last forever.

To use a free IRA calculator visit TurboTax Online. See how much can you contribute to an IRA and what the tax impact is.