Traditional Individual Retirement Accounts (IRAs) and Roth IRAs are tax-sheltered retirement accounts. Traditional IRAs allow you to contribute pre-tax income to an account where you pay no capital gains or dividend income taxes until you make a withdrawal (tax deferred). Roth IRAs are contributed to post tax but you pay no taxes when you withdraw your contributions, and you won’t pay federal taxes on your earnings, as long as the five-year aging requirement has been met.
The amount that you allowed to contribute annually to a traditional or to a Roth IRA changes annually and, for a Roth IRA, depends on your income level. The IRS website provides further information. For 2020, your total contributions to all of your traditional and Roth IRAs cannot be more than:
- $6,000 ($7,000 if you’re age 50 or older), or
- your taxable compensation for the year, if your compensation was less than this dollar limit.
From Traditional and Roth IRA accounts, you can make sustainable investments, either through a broker (including online brokers or robo-advisors), a financial advisor, or a financial institution that offers certificate of deposit (CD) IRAs. The investments may be sustainable mutual funds, index funds, ETFs, certificates of deposits, or other types of investments.
Comparison of Traditional and Roth IRAs
A comparison of Roth IRA and Traditional IRAs can be seen in the below table.
|Traditional IRA||Roth IRA|
|Tax benefits||Tax-deferred growth and tax-deductible contributions.||Tax-free growth and tax-free qualified withdrawals.|
|Age requirements||Contribute until you’re 70½.||Contribute at any age.|
|Income requirements||Your income does not affect how much you can contribute.||Your income affects how much you can contribute. See current limits.|
|Withdrawal taxes||You will pay taxes when you withdraw your pre-tax contributions and when you withdraw any earnings.||You won’t pay taxes when you withdraw your contributions, and you won’t pay federal taxes on your earnings, as long as the five-year aging requirement has been met.|
|Early-withdrawal penalties||If you make withdrawals before you’re 59½, you might have to pay a 10% penalty.||If you make withdrawals before you’re 59½, you might have to pay taxes on your earnings plus a 10% additional tax.|
|Required minimum distributions (RMDs)||RMDs must be taken starting in the year you turn 70½.||RMDs do not apply during your lifetime.|
|Contribution limits for 2019 and 2020||Total contributions to Roth IRA and traditional IRA cannot exceed $6000 for those under the age of 50||Total contributions to Roth IRA and traditional IRA cannot exceed $6000 for those under the age of 50|
Photo by Kelly Sikkema