Personal Finance

Roth vs. Traditional IRAs: To Convert or Not to Convert?

In establishing a retirement portfolio, deciding on the particular “flavor” combinations can be daunting.

As the New Year progresses and tax season quickly approaches, converting IRA accounts pops up as a timely option in personal finance advice outlets. Yet, without a clear understanding of the differences between Traditional and Roth IRAs, the decision can be even more intimidating.

It is important to note that these decisions should not be taken lightly, as they affect not only your future, but also the future of your dependents. Furthermore, there is no one-size-fits-all solution or right answer – the choice is personal and individualistic.

The Breakdown

There are some main differences between Roth and Traditional IRAs: income limitations, withdrawal regulations, future tax rates and tax incentives.

1. Income Limitations

For Traditional IRAs, anyone under the age of 70 years and six months who is earning an income can contribute.

For Roth IRAs, the account holder must meet certain income criteria in order to contribute.

2. Tax Incentives

Neither option is completely tax exempt, but Traditional vs. Roth IRAs function differently when it comes to taxing. Traditional IRAs are considered to have tax-deferred growth, while Roth IRAs are considered to have tax-free growth.

Traditional IRA contributions are tax deductible each year contributions are made. In other words, the money is taxed on the backend of its lifespan in the account, not the front.

Roth IRA contributions are not tax deductible during the year of contribution, but withdrawals (and the amount earned) are generally not taxed. Therefore, the account holder pays the tax on the account upfront and avoids the taxes once withdrawals are made.

3. Future Tax Rates

While the tax incentives for each account may seem straightforward enough, it is important to consider the potential for tax rates to increase or decrease within your lifetime.

The tax for Traditional IRAs will be determined by the tax rate during your retirement. The tax for Roth IRA contributions are determined by the current tax rate. Therefore, keep in mind the unpredictability of tax rates over the course of a lifetime and how close to retirement you currently are when considering converting from one account to another.

Therefore, while a Roth IRA may seem more appealing for those who have decades until their first withdrawal, it may not be the best fit for those approaching retirement in the next handful of years.

4. Withdrawal Regulations

Even though both IRAs are established for retirement withdrawal, the time one can begin withdrawing money from the account is different for each.

Traditional IRAs require the account holder to withdraw a minimum amount at 70.5 years old. At 59.5 years old, traditional IRA account holders can begin withdrawing tax- and penalty-free.

Roth IRAs do not require a minimum withdrawal at any point in the account holder's lifetime. Additionally, contributions (not any amount earned, though) to Roth IRAs can be withdrawn any time before retirement penalty-free.

Regardless of which option fits your situation best, the most important factor in the IRA conversation is to have an investment plan for your future. Take interest in your future and educate yourself on what options are available for you.

This article was written as a collaborative project between Benzinga’s Managing Editor Joe Young and Personal Finance writer Rebecca Sheppard.


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