The big difference between a traditional IRA and a Roth IRA is the way that income taxes are handled. With a traditional IRA, you don’t pay taxes on the money you put in since your IRA contribution is tax deductible. Instead, you pay your income taxes when you take the money out in retirement. With a Roth IRA, you pay your income taxes on your contribution before putting it in the Roth IRA, but it is all tax free when you take it out in retirement.
For example, let’s say you put $5,000 in a traditional IRA. You get a tax break now because you can deduct the entire $5,000. Your $5,000 grows tax free within your traditional IRA. You have to leave the money in the IRA until at least age 59.5, and then you can begin withdrawing the money. As you take the money out, you declare it on your tax return and pay your income taxes at that time. Presumably you will be in a lower tax bracket in your old age, so your tax bill will be lower.
Now let’s say you put $5,000 into a Roth IRA. You cannot deduct this amount on your tax returns, so you pay your regular income tax on the full $5,000. Then your $5,000 grows tax free within your Roth IRA. When you begin taking money out of your Roth IRA, it all comes out tax free.
There are other differences. Not everyone can deduct their traditional IRA contribution because there are income limitations. The traditional IRA has mandatory withdrawals after age 70.5, but there are no such mandatory withdrawals from a Roth IRA. Also, you can leave your money in a Roth IRA longer, and you can withdraw your contributions any time without taxes, but not the investment proceeds.