Traditional IRAs
The tax breaks for a traditional IRA are of the “this is tax-deductible” kind. That means that, depending on previously discussed factors, the money you deposit in your IRA isn’t taxed. And regardless, whatever earnings you have on your contributions won’t be taxed until you withdraw that money many years later.For example, let’s say you made $30,000 during the year, and you put $2,000 of it into an IRA. You would pay income tax on only $28,000. Additionally, your deposit will grow free of tax through the years. When you finally withdraw the money for your retirement — after age 59 1/2 — then, and only then, will the money be taxed as income at your ordinary income tax rate.
Roth IRA
The tax breaks for a Roth IRA are different. Unlike a contribution to a traditional IRA, a Roth IRA contribution is never deductible. Taking the above example, you’d still be taxed on $30,000 even though you had put the same $2,000 into a Roth IRA. However, when you withdraw the money from a Roth IRA, none of it — and that includes the earnings — will be taxed, assuming that the Roth IRA has been open for at least five tax-years and you are older than age 59 1/2. All you have to do is to wait until you can withdraw it penalty-free. Again, that’s after age 59 1/2, and as long as it’s been in there for at least five years.
In other words, the Roth offers tax-exempt rather than simply tax-deferred savings. One word makes a big difference. While both allow you to accumulate wealth without paying taxes along the way on your profits, the Traditional IRA monies are taxable upon withdrawal. The Roth IRA monies are not. As long as you follow the rules, you never pay taxes on your gains.