What distinguishes a Roth IRA from a traditional IRA?

A Roth IRA is distinguished from a traditional IRA primarily by the nature of its tax treatment concerning withdrawals. In a Roth IRA, contributions are made with after-tax dollars, meaning that they are not tax-deductible in the year they are contributed. However, one of the significant advantages of a Roth IRA is that qualified withdrawals, including both contributions and earnings, are completely tax-free in retirement, provided certain conditions are met. This tax-free growth and withdrawal can be particularly beneficial for individuals who anticipate being in a higher tax bracket during retirement.

On the other hand, traditional IRAs allow for tax-deductible contributions, which defer taxation until funds are withdrawn, typically during retirement when the individual's tax rate may be lower. Additionally, eligibility for a Roth IRA does have income limits, meaning it is not only available to high-income earners, but rather primarily to those whose income falls below a specified threshold. There are also specific annual contribution limits, which are set based on various factors, including age, but the particular figure mentioned in one of the alternatives is not accurate as contribution limits can vary and are indexed for inflation.

Understanding these differences is crucial for effective retirement planning, as they can significantly impact a person's tax situation and retirement income strategy.