What is the difference between a traditional IRA and a Roth IRA?

A traditional IRA and a Roth IRA serve as two distinct types of individual retirement accounts, primarily differing in how and when taxes are applied to contributions and withdrawals.

The correct answer highlights that contributions to a traditional IRA can often be deducted from taxable income in the year they are made. This means that individuals can reduce their current taxable income by the amount they contribute, allowing for a potential tax benefit upfront. In contrast, contributions to a Roth IRA are made with after-tax dollars; individuals do not receive a deduction at the time of contribution, meaning they pay income tax on that money before it goes into the account.

This fundamental difference in tax treatment shapes not only how contributions are made but also affects the way funds can be withdrawn in retirement. While money in a traditional IRA is taxed upon withdrawal, qualified withdrawals from a Roth IRA are tax-free, provided certain conditions are met. This makes the choice between the two types of IRAs significant, as it can influence an individual’s overall retirement strategy depending on their current tax rate and anticipated tax rate in retirement.

Overall, understanding this distinction helps individuals make more informed decisions about their retirement savings strategy based on their current financial situation and future goals.