Traditional vs. Roth
| Traditional IRA | Roth IRA | |
|---|---|---|
| Contribution | Potentially deductible (phased out if covered by an employer plan) | Never deductible |
| Growth | Tax-deferred | Tax-free |
| Qualified distribution | Taxable as ordinary income | Tax-free |
| Required minimum distributions | Yes | None during the owner's lifetime |
| Income limits to contribute | No (deduction may be limited) | Yes |
IMPORTANT — the Roth qualified distribution test: A Roth distribution is tax-free only if the 5-year holding period is met AND one of: age 59½, death, disability, or first-time home purchase (up to a lifetime limit). Contributions (not earnings) can always be withdrawn tax- and penalty-free.
Early distribution penalty
Distributions before age 59½ generally incur a 10% additional tax on top of ordinary income tax. Exceptions include: death, disability, qualified higher education expenses, first-time home purchase (IRAs, limited), substantially equal periodic payments, medical expenses above the AGI threshold, and a qualified birth or adoption.
Employer plans
- 401(k) — elective deferrals reduce taxable wages (but not Social Security/Medicare wages); employer matches are not currently taxable
- SEP — employer-funded, useful for self-employed taxpayers
- SIMPLE — for small employers, with mandatory employer contributions
- Defined benefit — promises a specified benefit; employer bears the investment risk
EXAM TIP: A direct trustee-to-trustee rollover avoids withholding entirely. An indirect (60-day) rollover from an employer plan triggers mandatory 20% withholding, and the taxpayer must replace that withheld amount from other funds to roll over the full balance.