Traditional IRA or Roth IRA? How to decide which one's right for you

Most financial experts agree that opening an IRA account can be a smart way to save for retirement.

Whether you choose the Roth or traditional version, you can expect some pretty nice tax advantages and a variety of investment options to pick from, including mutual funds, annuities, CDs, stocks and bonds, and exchange-traded funds. IRAs are also a great alternative for those unable to contribute to an employer-sponsored 401(k) plan.

And while you probably won't go wrong with either, the advantages to each account vary based on your financial situation. If you're having trouble deciding which savings option is right for you, here are a few things to consider.

Taxes

A major difference between a traditional IRA and a Roth IRA is the timing of the primary tax benefit associated with each.

A traditional IRA may allow you to deduct your contribution if you meet IRS limits based on your income and filing status, or if you or your spouse is covered by an employer's retirement plan. If you're seeking a deductible, the traditional IRA offers income tax benefits today.

With a Roth IRA, the major tax benefit comes later. If you meet a few IRS guidelines, your contributions and all your earnings over the years will be available tax free at retirement.

Both Roth and traditional IRAs shelter your money from taxes until withdrawals are made. So regardless of which option you choose, you won't be paying taxes on interest, dividends, or capital gains on your road to retirement.

Eligibility

IRA contributions can only be made from taxable compensation. If you're married, you may be able to make a contribution based on your spouse's income.

Each type of IRA is subject to IRS limits which could eliminate some of their tax benefits or even eliminate them as an option all together. With traditional IRAs, it's a question of deductibility. As previously noted, not everyone is eligible to deduct their contributions.

With Roth IRAs, income can dictate whether or not you're even able to make a contribution. If your household income is too high based on your filing status, Roth IRA contributions aren't allowed. Talk to your tax adviser or visit the IRS website to determine where you stand.

Your combined contribution to Roth and traditional IRAs is capped at $5,500 a year for those under the age of 50, and $6,500 a year for those who turn 50 or above by December 31. Contributions for the previous year can be made up until the tax filing deadline of the following year. For example, you can make a 2014 IRA contribution up until April 15, 2015.

Withdrawals

While there are exceptions, those with traditional IRAs will pay taxes and face a 10% penalty for any withdrawals made before age 59 1/2. On the other hand, Roth IRA contributions can be withdrawn at anytime without any taxes or penalties. However, the earnings on contributions made to a Roth are subject to federal income taxes and penalties if you withdraw before you're 59 1/2.

So what's the best option?

It may make more sense for people in their 20s or 30s to contribute to Roth IRAs even if they expect slightly lower tax rates in retirement. The Roth advantage starts to diminish slightly when people enter their peak earning years, typically in their late 40s and beyond. At that time, contributing to a traditional IRA may be preferable.

No one can predict with certainty what their financial situation will be at retirement, so it may make sense to use both types of accounts in your retirement savings plan.

To learn more about retirement planning, visit USAA's website.

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The contents of this document are not intended to be, and are not, legal or tax advice. The applicable tax law is complex, the penalties for non-compliance are severe, and the applicable tax law of your state may differ from federal tax law. Therefore, you should consult your tax and legal advisers regarding your specific situation.

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