Individual retirement arrangements (IRAs) allow you to make tax-advantaged contributions that may produce more significant gains than investments without similar tax advantages.
Most people are eligible to open both traditional and Roth IRAs. While they have several similarities, they also offer different features and advantages that may make one a better option than the other, depending on individual circumstances.
Table of Contents
Traditional and Roth IRAs have tax advantages that make them good options for your retirement investments. The main difference between them is how and when you pay taxes on them. A traditional IRA is a tax-deferred retirement plan, and a Roth IRA is a tax-exempt retirement plan.
In other words, the difference between the two retirement plans is how and when you pay taxes on them.
How Traditional IRAs Work
You make traditional IRA contributions with pre-tax money that will grow tax free until you make withdrawals at retirement age or under certain circumstances. If you are eligible to contribute to a tax-deductible traditional IRA based on your income, you’ll record the tax benefit when you file your taxes the following year, usually by reducing your taxable income by the amount of the contribution.Check out the IRA contribution limits to find out if you are eligible for tax-deductible contributions. The IRS taxes the money from traditional IRAs when you withdraw it. With traditional IRAs, you are also subjected to required minimum distributions starting at age 70½.
How Roth IRAs Work
You make Roth IRA contributions with money that you’ve already paid taxes on, and contributions are not tax-deductible when you make them. However, since you make the contributions with after-tax money, you can make tax-free qualified distributions. There are no required minimum distributions for Roth IRAs, which gives you more flexibility in retirement.
Please see the link above for Roth IRA income and contribution limits for more information about Roth IRA eligibility. Early withdrawal rules still apply; however, other tax rules permit withdrawals for events such as buying your first house, paying for college and others. Please visit the IRS website or contact a tax professional for more details.
Beware of Early Withdrawal Penalties
Making withdrawals before you reach retirement age may subject you to early withdrawal penalties. These penalties can cost you 10% of what you withdraw, and you’ll have to pay taxes on the amount you withdraw immediately. You can lose a large portion of your retirement fund by making early withdrawals.
Side-by-Side IRA Comparison Table
| Features | Traditional IRA | Roth IRA |
|---|---|---|
| Who can contribute? | You can contribute at any age if you (or your spouse filing jointly) have taxable compensation. | You can contribute at any age if you (or your spouse if filing jointly) have taxable compensation and your modified adjusted gross income is below specific amounts (see IRA Contribution Limits). |
| Are my contributions deductible? | You can deduct your contributions if you qualify. | Your contributions aren't deductible. |
| How much can I contribute? | The most you can contribute to all of your traditional and Roth IRAs is the smaller of: - For 2024, $7,000, or $8,000 if you're age 50 or older by the end of the year or your taxable compensation for the year. - The income limits for tax deductions for traditional IRAs and income limits for Roth IRA eligibility. See below for more information. | The most you can contribute to all of your traditional and Roth IRAs is the smaller of: - For 2024, $7,000, or $8,000 if you're age 50 or older by the end of the year or your taxable compensation for the year. - The income limit for tax deductions for traditional IRAs and income limits for Roth IRA eligibility. See below for more information. |
| What is the deadline to make contributions? | Your tax return filing deadline (not including extensions). For example, you can make 2023 IRA contributions until April 15, 2024. | Your tax return filing deadline (not including extensions). For example, you can make 2023 IRA contributions until April 15, 2024. |
| When can I withdraw money? | You can withdraw money anytime. However, there may be tax implications if you withdraw before age 59½. | Roth IRA contributions can be withdrawn penalty-free at any time. However, there may be tax implications if you make earnings withdrawals before age 59½. See Roth IRA withdrawal rules for more information. |
Traditional IRA Features
Eligibility
In 2020, the IRS removed the age limit on making contributions to your IRA. However, you must still meet certain income requirements to deduct your contributions from your taxes. You can still contribute to a traditional IRA if you exceed income requirements, but it will be in a nondeductible IRA.
Contributions
You must make your contributions from taxable, earned income. This includes salary, wages, commissions, nontaxable combat pay and self-employment income. Excluded income includes rent, dividend income and other non-taxable income.
A note about earned income requirements: Military members who are deployed to a tax-exempt combat zone for an entire year typically do not have any earned income for tax purposes. These members are still eligible to contribute to either a traditional or Roth IRA through provisions in the HERO Act).
Taxes
You make traditional IRA contributions from income you have not yet paid taxes on. This reduces your taxable income when you file your tax return, giving you an immediate tax advantage. You defer the taxes and pay them when you make withdrawals.
Tax Deduction Rules
| Filing Status | Modified AGI | Deduction |
|---|---|---|
| Single or head of household | $77,000 or less | Full deduction up to the amount of your contribution limit |
| More than $77,000 but less than $87,000 | Partial deduction | |
| $87,000 or more | No deduction. | |
| Married filing jointly or qualifying widow(er) | $116,000 or less | Full deduction up to the amount of your contribution limit |
| More than $123,000 but less than $143,000 | Partial deduction | |
| $143,000 or more | No deduction | |
| Married filing separately | Less than $10,000 | Partial deduction |
| $10,000 or more | No deduction | |
| If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the "Single" filing status. | ||
Distributions
You can begin taking penalty-free withdrawals at age 59½. If you make withdrawals before that age, you may pay taxes on the withdrawals, as well as an early withdrawal penalty, which may be up to 10% of your withdrawal. Speak with a tax professional or the IRS for further guidance.
You must also make required minimum distributions (RMDs), starting at the age of 70½. It’s a good idea to meet with a tax professional before you begin your RMDs to ensure you are making sufficient withdrawals. Otherwise, you might subject yourself to additional penalties.
Roth IRA Features
Eligibility
Taxpayers must meet Roth IRA income-eligibility requirements to be eligible to contribute to a Roth IRA. The Roth IRA income limits change each year and are based on your tax-filing status.
| Filing Status | Modified AGI | Allowable Contribution |
|---|---|---|
| Married filing jointly or qualifying widow(er) | $230,000 or less | Up to the annual contribution limit |
| More than $230,000 but less than $240,000 | Partial amount | |
| $240,000 or more | No contribution | |
| Married filing separately and you lived with your spouse at any time during the year | Less than $10,000 | Reduced amount |
| $10,000 or more | No contribution | |
| Single, head of household or married filing separately and you did not live with your spouse at any time during the year | $146,000 or less | Up to the annual contribution limit |
| More than $146,000 but less than $161,000 | Partial contribution | |
| $161,000 or more | No contribution |
Contributions
Annual IRA contribution limits are the same for both Roth and traditional IRAs. Like the traditional IRA, you must make Roth IRA contributions from earned income.
Taxes
The main difference between Roth and traditional IRAs is how and when you pay taxes on the funds. You make Roth IRA contributions from money you have already paid taxes on (post-tax income). You don’t have to pay further taxes on the investments as they grow, and you also won’t have to pay taxes on the distributions when you make withdrawals. This gives participants much more flexibility regarding how and when they take funds from their Roth IRAs.
Distributions
Unlike traditional IRAs, there are no required minimum distributions to worry about. You can leave your money in your Roth IRA until you need it. You can access contributions to your Roth IRAs at any time. However, you cannot access the earnings from your contributions until the account has been open for at least five years and you have reached age 59½. Taking withdrawals earlier than that may subject you to early withdrawal penalties.
Which is Better, Traditional or Roth IRA?
There is no one-size-fits-all approach to this question. The answer depends on your unique circumstances. Both types of IRAs can offer you the opportunity for tax diversification and more flexibility in retirement.
Factors to Consider
There are many factors to consider when comparing Roth and traditional IRAs, including your current tax bracket and your expected tax bracket in retirement. You also need to consider current income, expected future income, Roth or traditional IRA income eligibility, contribution limits and required minimum distribution requirements.
Tax-free traditional IRA contributions phase out at lower income levels than Roth IRAs. So, you may consider a Roth if you cannot receive the tax deductions from a traditional IRA. Traditional IRAs also have minimum withdrawal requirements, while Roth IRAs do not.
Which Is Better?
Many financial experts recommend you start investing with a Roth IRA if you are eligible because they offer tax-free withdrawals and other benefits such as higher income levels for eligibility and no required minimum distributions. Overall, they provide more flexibility than traditional IRAs. That said, there are times when a traditional IRA is the right choice.
We have two articles that further compare the pros and cons of Roth and traditional IRAs:
- Six Reasons to Choose a Roth IRA over a Traditional IRA
- Five Reasons to Choose a Traditional IRA over a Roth IRA
Take some time to consider your situation before deciding which IRA to open. The long-term benefits are worth getting it right the first time.
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Credit Card Chaser says
The choice really all boils down to whether you think that you tax rate will be higher now or higher when you retire.
Britt (Your Roth IRA) says
While every financial circumstance is different, I think most people would benefit more from a Roth IRA. Why? Well, the odds are pretty good that tax rates will be higher in the future than they are now, given the massive size of the national debt. So the idea that rates might go down when you retire is wishful thinking at best. Also, if you’re already thinking about retirement, the odds are good that you won’t need your Roth IRA funds immediately once you retire, nor will they be your sole source of income. So do you want to box yourself in to mandatory withdrawals at age 70.5? Especially is you live to be 100 or older?
I just don’t see how you can go wrong with the tax-free withdrawals of a Roth IRA.