Which IRA offers the best tax benefits?

It's a rather frightening statistic that one out of every three Americans has no money saved for retirement. If you don't have access to an employer-sponsored retirement plan, which is the case for over 40% of workers, your next best bet is to open an IRA, or individual retirement account. The two most popular IRA types are the traditional and the Roth, and while they're similar in certain regards (namely, annual contribution maximums), they differ in terms of the tax benefits they offer.

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How traditional and Roth IRAs are similar

Both traditional and Roth IRAs are designed to help you achieve the same goal: saving for retirement. With either account, the money you contribute gets to grow on a tax-deferred basis, which means you won't pay taxes on any of your investment gains between now and retirement. There's a limit, however, as to how much you can contribute each year. For 2017, the maximum annual contribution is $5,500 if you're under 50. If you're 50 or older, you're allowed a $1,000 catch-up for a total of $6,500. Both traditional and Roth IRAs offer a range of investment options to help your money grow. But when it comes to taxes, there are numerous differences that could help drive your decision on which to choose.

RELATED: 10 things we've all said while filing taxes:

10 things we've all said while filing our taxes
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10 things we've all said while filing our taxes

"It's only January, I have plenty of time!"
You're relaxed, you're casual, what even are taxes anyway? You don't care! It's so far away that filing taxes isn't even remotely on your radar, to be honest.

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"The imminent act of filing is upon me and I literally have nothing ready..."
Tax season is now approaching and that creeping anxiety about getting everything done on time is starting to set in. It's essentially biting at your heels and you know you have to get moving.

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No words. Just emotional paralysis.
You're screwed. You need to start doing your paperwork but you physically do not know where to even begin. It's time. It's happening.

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That anxiety you felt creeping in earlier? Now it's full-fledged onset. This stage is often accompanied by screaming out loud, pulling hair, crying, etc.

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"Wait, did I get all of my papers in? Did I check that one box correctly? Does it look like I'm trying to evade some of these taxes? What if I go to jail? Can I go to jail for that? WHO WILL FEED MY DOG WHEN I AM IN JAIL?!"

It's like handing in an exam in school and wishing you could grab it back and double check your answers one more time.

Who was that celebrity you heard about that went to jail for tax evasion? Because now you're convinced that's totally going to be you.

Spoiler alert: as long as you did everything to the best of your knowledge and ability, you probably won't go to jail. And even if you do, you'll find someone to walk your dog.

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"I got this, I'm almost done, a few more papers and I'm in the clear. I just have to pound through the rest of it. Go me!"

"Go you" is right! Now you're on cruise control and you're on track to get everything done well and on time. You're unstoppable in the delight of the world that is tax filing.

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"Thank god that's over with, now I can relax! What to do with all this stress-free free time!"
Finally, relief. Your papers are filed and sent out into the universe. It's off your back at last. Now on to more important things, like Netflix.

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"When is my return coming? Is this going to be my life for the rest of my life? Yep, it is. So about that return..."
Now, you wait. You want that money. And the inevitable truth that your life will now be a neverending cycle of filing taxes and waiting for your return.

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"SCORE my return was so much better than I expected! I'm buying a new dress. Or five. Probably five, why not?"
You're on a total life-high now. The possibilities of what you can spend your return on seem endless and even if you don't, having a nice bonus hunk of cash in your pocket feels pretty good. It made all of that stress completely worth it.

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"Honestly filing wasn't even that bad this year. And now I don't have to think about it anymore. Well at least not for another year. But no use in worrying about that now!"
Alas, acceptance. You know you'll fall victim to the vicious cycle again when next year rolls around. But truthfully, you wouldn't have it any other way. Okay, you obviously would. But you'll never change your procrastinating ways!

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Tax benefits of traditional IRAs

In addition to offering tax-deferred growth, traditional IRAs offer the benefit of tax-free contributions. (Note that if you have access to a retirement plan through your job, or if your spouse has access to one at work, you may not get this benefit depending on your income level.) Typically, you'll get a tax break the year you contribute to your traditional IRA, and you won't pay any taxes until the time comes to take withdrawals in retirement. At that point, however, your distributions will be taxed as ordinary income.

Tax benefits of Roth IRAs

One downside to the Roth IRA is that it doesn't give you an up-front tax break. Roth contributions are made with after-tax dollars, so if you're looking for a way to lower your current tax burden, a Roth won't solve that problem. On the other hand, once your money goes into a Roth, you won't ever have to worry about paying taxes on it again. Withdrawals in retirement are made tax-free, and you won't pay taxes on your investment gains along the way.

Required minimum distributions

Another factor to contemplate when comparing IRAs is mandated withdrawals from your plan. Currently, traditional IRAs force you to start taking required minimum distributions (RMDs) once you turn 70-1/2. This can be problematic if you're at a point in your life where you don't need the money, since your RMD will automatically trigger a tax situation.

Imagine, for instance, that you decide to work until age 75 and therefore don't need to tap your retirement savings until then. With a traditional IRA, you'll be required to take an initial withdrawal by April 1 of the year following the calendar year in which you turn 70-1/2, regardless of whether you want or need it. Not only will you lose out on the opportunity to keep that money invested, but that extra cash could bump you into a higher tax bracket if you're bringing in a solid salary already.

But you can't ignore your RMD either. If you fail to take your required distribution, you'll be assessed a 50% penalty on whatever amount you neglect to withdraw. All of this highlights another tax benefit of the Roth IRA. Because Roths don't impose RMDs, you can leave your money invested indefinitely.

Other points to consider

Though Roth IRAs offer a number of tax benefits that traditional IRAs can't match, not everyone is eligible to open one. If you earn more than $132,000 this year as a single tax filer or $194,000 as a couple filing jointly, you won't be allowed to contribute. However, you can get around this restriction by opening what's known as a backdoor IRA, which essentially lets you convert a traditional IRA to a Roth.

Another thing to keep in mind is that removing money from a traditional IRA prior to age 59-1/2 will result in a 10% early withdrawal penalty, plus taxes on your distribution. Though there are some exceptions, this rule is meant to serve as a deterrent from touching those retirement funds prematurely.

With a Roth IRA, however, you're allowed to withdraw your principal contributions (not your earnings) penalty-free at any time for any reason, and doing so won't create a tax liability since you've already paid taxes on that money. But while this provision allows for more flexibility, it can also too easily open the door to temptation. Remember, that money is supposed to serve as a key source of retirement income, so the fact that you can remove it early isn't necessarily a good thing.

Because traditional and Roth IRAs each offer unique tax benefits, it's important to weigh your options before deciding which type to choose. No matter which one you open, remember to start funding it early to give your money time to grow. The sooner you begin saving, the greater your chances of amassing a respectable nest egg that will serve your needs in retirement.

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