How Does the Roth IRA Tax Deduction Work?

The Roth IRA tax deduction occurs on the back end of the account instead of the front end, making it a unique strategy for retirement savings. You will pay taxes on the contributions you make to your account in the year that you make them. Then, the funds grow tax free and are withdrawn tax free in the future.

Roth vs. Traditional IRA

Traditional IRA contributions are deducted from taxes on the front end, allowing a person to place pre-tax dollars in the account. The funds grow tax free, and then taxes are incurred on the back end. The individual owes taxes at his or her given tax rate at the time of withdrawal.

Who should Use a Roth IRA?

The Roth IRA is best for a person who believes they will have a higher tax bracket at the age of withdrawal than they have in the current year. This way, it makes sense to pay taxes at the current tax rate than at future tax rates. Since the contribution limits on a Roth IRA are low, they are traditionally used by lower-income or young individuals who are only contributing a small amount of money on an annual basis.

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