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The most important difference between a traditional and a Roth IRA is how the tax benefits work. With either, all money in the account is sheltered from all taxes while it remains in the account. With a traditional IRA, contributions are tax-exempt. You pay regular taxes on all funds withdrawn from the account once you retire. Also, you must begin mandatory minimum distributions when you reach age 70 1/2. With a Roth IRA there is no up-front tax deduction; the contributions to the fund have already been taxed. When you withdraw money after retirement, the earnings on investments you've made are tax free. You may also leave funds in a Roth IRA as long as you wish.
Another important distinction is that contributions (but not earnings or funds rolled over from another retirement plan) may be withdrawn from a Roth IRA (but not a traditional IRA) without penalty at any time. The IRS uses a set of "ordering rules" that define any withdrawals as contributions unless the amount withdrawn exceeds total contributions.
Traditional IRAs are most popular with people in high tax brackets since the tax exemption is substantial. Someone in a lower tax bracket is more likely to choose azoth IRA because the tax free status of earnings provides a better long-term benefit. -
Failure to follow IRS rules governing early withdrawals makes the money withdrawn subject to a penalty tax of 10 percent on top of regular taxes. In addition, you must follow IRS restrictions on investment types. You may not invest in antiques or other collectible items, in precious metals except U.S. Mint investment coins, or in leveraged securities (options, stocks bought on margin, and so on).
There are some exceptions that allow early withdrawal of funds. You may take money from an IRA to help buy a first home or for certain educational expenses (there is a $10,000 limit on home buying withdrawals for Roth IRAs). If you inherit an IRA, you can take the money out without penalty. A person who is disabled can also take funds out without penalty. If you lose your job, you can use IRA funds to pay health insurance premiums while you are out of work. Finally, if you have health care expenses that total more than 7 1/2 percent of your adjusted gross income and not paid by insurance, you can use IRA funds to pay them.
