Early In My Career: Is it necessary to understand the difference between a Traditional and a Roth IRA?

During our college years the thought of retirement is way down the road, so far down the road, a lot of college students and recent graduates don’t even bother thinking about it. There is a false notion that people do not need to start thinking about retirement until we are well into our careers. However, becoming aware of what retirement plans can offer and contributing to them early can make your retirement that much more enjoyable.

Many people are confused about the difference between a Traditional and a Roth IRA, or if a difference even exists between the two. An IRA is an abbreviation for Individual Retirement Account; it is available for any working Americans. The two most common IRA’s are the Traditional and the Roth IRA.

In a Traditional IRA, the account owner puts pre-tax dollars into their account. Once the owner withdraws their money from the account they then pay ordinary income tax on the withdrawals.

In a Roth IRA the individual pays tax on income, then puts after-tax dollars into their Roth account. If the money has been in the account for at least five years and the owner is 59 ½ years old the principle and earnings are both tax-free when they decide to withdraw from the account. Roth IRA’s are typically a good idea for young people because they have many years for earnings to grow tax-free. Roth IRA’s also appeal to those who believe their tax bracket is likely to be higher in the future.

For more details about the differences between the two, read Traditional and Roth IRA’s, https://www.irs.gov/retirement-plans/traditional-and-roth-iras

 

Written by: Brandon Wyeth, Financial Wellness Peer Educator, University of Illinois Extension, 2017

Reviewed by: Kathy Sweedler, Consumer Economics Educator, University of Illinois Extension, 2017