Last week we discussed your retirement nest egg knowledge. The study I mentioned in that article described the lack of information many people have about traditional IRA accounts versus Roth IRAs, so I thought I would break it down in a clear and simple manner.

Including a Roth IRA in your overall retirement planning can be a profitable choice. The main reason is because a Roth has the potential to grow tax-free, which can save you a bundle of money over time.

Other advantages of Roth IRAs include withdrawals not being mandatory during the lifetime of the original owner, and the fact your assets from that type of account may pass to your heirs tax-free. Also, once you've held a Roth account for five years, you won't owe the IRS anything when you withdraw the money at retirement.

While a traditional IRA account also provides generous tax breaks, it is taxed at the time you start withdrawing money from it. That tax amount will be at your ordinary income rate, which could be as high as 39.6 percent (in 2014). In many cases, the longer you wait to withdraw the funds, the higher your income bracket will be, and the more you’ll be taxed.

Ultimately, the decision to contribute to a traditional or Roth IRA should depend on whether you expect your income tax rate in retirement to be higher or lower than what you currently pay. That’s because it determines whether the tax rate you currently pay on your Roth IRA contributions is higher or lower than what you’d pay on your traditional IRA’s withdrawals in retirement.

One major difference between traditional IRAs and Roth IRAs is when your funds must be withdrawn. Traditional IRAs require you to start taking required minimum distributions at age 70 1/2, while Roth IRAs has no such rule.

In other words, if you don’t need an income stream from your Roth IRA, it can continue to grow tax-free throughout your lifetime, making it a prime way to transfer wealth to your loved ones after your death.

Both traditional and Roth IRAs allow owners to begin taking penalty-free, “qualified” distributions at age 59 ½. However, Roth IRAs require that the first contribution be at least five years before qualified distributions begin.

So how do you know if a Roth IRA is the right choice for you? After considering the above facts, it’s also a good idea to meet with a professional that is familiar with your personal financial situation and can make a educated recommendation.

Author Ron L. Brown, CFP®

Ron is a CERTIFIED FINANCIAL PLANNER™ and president of R.L. Brown Wealth Management. He specializes in retirement, estate, and business planning for professionals and entrepreneurs. Ron assists his clients with creating a financial plan to ensure they are able to live their ideal lifestyle during retirement and leave a strong legacy for their family. Ron has been featured in The Wall Street Journal, US News, Yahoo Finance, Investopedia, and numerous other high profile financial publications.

More posts by Ron L. Brown, CFP®

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