What is the key difference between a traditional IRA and a Roth IRA?

The key difference between a traditional IRA and a Roth IRA lies in how contributions are taxed. With a traditional IRA, contributions are often tax-deductible, which allows individuals to reduce their taxable income for the year in which they contribute. Therefore, individuals may benefit from immediate tax savings by lowering their tax obligations now. However, withdrawals during retirement are subject to income tax since taxes were deferred until that time.

In contrast, contributions to a Roth IRA are made with after-tax income, meaning that there are no tax deductions at the moment of contribution. The significant advantage of a Roth IRA comes during retirement because withdrawals, including both contributions and earnings, can be taken out tax-free, provided certain conditions are met. This allows individuals to potentially benefit from tax-free growth, which can be particularly favorable if they expect to be in a higher tax bracket in retirement.

Understanding this distinction helps individuals make informed decisions based on their current financial situation and anticipated future tax implications. The other choices do not accurately capture this critical difference in taxation, which is essential for anyone considering the long-term impact of their retirement savings strategies.