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Quick Bites
- A traditional IRA and a Roth IRA are both tax-advantaged accounts that you can use to save for retirement.
- With an IRA, you get an upfront tax benefit, while with a Roth IRA, you get a tax benefit on your retirement distributions.
- An IRA makes more sense if you think your tax rate will be lower during retirement; a Roth IRA may make more sense if you think your tax rate will be higher during retirement.
When you’re saving for retirement, there are plenty of accounts you can use to make the most of your investments. Individual retirement accounts, or IRAs, allow you to open and manage your own retirement savings. That’s different from a 401(k), which is an employer-sponsored retirement savings plan that you open at the company you work at, if it’s offered.
There are also individual retirement accounts or IRAs, with the most popular types being a traditional IRA and a Roth IRA. Both can be good options to save for retirement, but there are some key differences.
Read on to find out how these two IRAs work, how they’re different, when it makes sense to open one versus the other, and where to open an IRA or Roth IRA account.
Roth IRA and traditional IRA comparison
A traditional IRA allows you to make tax-deductible contributions. Once the money is in the account, it grows tax-free until you retire, at which point you’ll pay income taxes on your earnings.
With a Roth IRA, you contribute with after-tax money. Your funds grow tax-free while they’re in the account, and you can withdraw them tax-free during retirement.
Here’s a quick look at the features a traditional IRA and a Roth IRA have to offer.
Features | Traditional IRA | Roth IRA |
---|---|---|
Contributions | $6,000 per year. $1,000 catch-up contribution age 50 or older. | $6,000 per year. $1,000 catch-up contribution age 50 or older. |
Taxes | Pre-tax contributions. Tax-deferred growth. Taxes on withdrawals during retirement. | After-tax contributions. Tax-free growth. Tax-free withdrawals during retirement. |
Income limits | Limited contributions after income of $204,000 for single filers and $129,000 for married filers. No contributions after income of $214,000 for single filers and $144,000 for married filers. | No income limit on contributions. |
Contribution tax deductions | Limited deduction after income of $68,000 for single filers or $129,000 for married filers, if you’re covered by a retirement plan at work. No deduction after income of $78,000 for single filers or $129,000 for married filers, if you’re covered by a retirement plan at work. | N/A |
Withdrawals | Taxes on earnings and contributions during retirement. | Tax-free withdrawals of contributions anytime and tax-free withdrawals of earnings during retirement, as long as it’s been five years since your first contribution. |
Early withdrawals | You will owe income tax and a 10% penalty for early withdrawals of both contributions and earnings. Exceptions include: qualified higher education expenses; qualified first home purchase; certain major medical expenses; long-term unemployment expenses; death; disability | You will owe income tax and a 10% penalty for early withdrawals of earnings only. Exceptions include: qualified higher education expenses; qualified first home purchase; certain major medical expenses; long-term unemployment expenses; death; disability |
Required minimum distributions (RMDs) | Mandatory starting at age 72. | None |
Now let’s take a closer look at each feature of a traditional and a Roth IRA.
Contributions
Both accounts allow you to contribute up to $6,000 per year. If you’re 50 or older, you can contribute an additional $1,000 per year as a catch-up contribution, for a total contribution of $7,000 per year.[1]
It’s important to note, however, that while the contribution limit is $6,000, you can only contribute as much as your earned income for the year. If you didn’t earn at least $6,000 in a year, then you’re limited to contributing the amount you did earn. You can however, qualify for a spousal IRA if you spouse has earned income and can open one in your name.
Taxes
In the case of a traditional IRA, the tax benefit comes at the time you make the contribution. You can deduct the amount you contribute from your taxable income, which helps to reduce your tax burden in that year. When you withdraw funds during retirement, you’ll pay income taxes on the entire amount.
With a Roth IRA, you can’t deduct your contributions, meaning they don’t lower your tax burden at the time. However, the funds grow tax-free in your retirement account and you can withdraw them tax-free during retirement.
While they have different tax treatments when you withdraw money during retirement, as long as the money remains in the account, you won’t pay taxes on your capital gains, dividends and interest.
Income limits
Another key difference between a Roth and a traditional IRA is their income limits. Each type of account does have some sort of income limit, but with different consequences.
Roth IRA
Only investors under a certain annual income can contribute to a Roth IRA. The IRS has a tiered system, where the amount you can contribute decreases as your income increases. Only workers in the lowest income tier can contribute the full $6,000 per year.
Here’s how much you can contribute based on your income[2]:
Filing status | Modified AGI | Contribution allowed |
---|---|---|
Married filing jointly or qualified widower | Less than $204,000 | Up to the contribution limit |
Married filing jointly or qualified widower | $204,000 - $214,000 | A reduced amount |
Married filing jointly or qualified widower | $214,000 or more | None |
Married filing separately | Less than $10,000 | A reduced amount |
Married filing separately | $10,000 or more | None |
Single, head of household, or married and both filing and living separately | Less than $129,000 | Up to the contribution limit |
Single, head of household, or married and both filing and living separately | $129,000 - $144,000 | A reduced amount |
Single, head of household, or married and both filing and living separately | $144,000 or more | None |
Traditional IRA
In the case of a traditional IRA, there is no income limit to be able to contribute. Whether you earn $25,000 per year or $250,000, you can contribute to a traditional IRA. However, depending on your income, you may not be able to deduct your contributions.
Tax deductions on contributions
While contributions to traditional IRAs are generally tax-deductible, there may be limits on the amount of contributions you’re allowed to deduct, or even whether you’re allowed to deduct them at all.
You need a minimum level of earned income of $6,000 to be eligible to contribute to a traditional IRA. After that, “the tax-filing status, the amount of earned income, and participation status in an employer-sponsored retirement plan determine deductibility,” says Ernest Lacroix, a financial planner and the founder of Achieve Financial Solutions.
The income limitations in this table for traditional IRA deductions apply only if you or your spouse already have a retirement plan at work (otherwise you can deduct your full contributions no matter what your income level is).[3]
Filing status | Modified AGI | Deduction allowed |
---|---|---|
Married filing jointly or qualified widower | $109,000 or less | Full deduction |
Married filing jointly or qualified widower | $109,000 - $129,000 | Partial deduction |
Married filing jointly or qualified widower | $129,000 or more | No deduction |
Married filing separately | Less than $10,000 | Partial deduction |
Married filing separately | $10,000 or more | No deduction |
Single or head of household | Up to $68,000 | Full deduction |
Single or head of household | $68,000 - $78,000 | Partial deduction |
Single or head of household | $78,000 or more | No deduction |
Withdrawals
As with other types of tax-advantaged retirement accounts, both traditional and Roth IRAs have restrictions around withdrawals. For both accounts, you can’t make withdrawals from your account until you reach age 59½. However, both accounts allow for a number of exceptions, including[4]:
Death
Disability
Qualified higher education expenses
Qualified first-time home purchase
Unreimbursed medical expenses
Health insurance premiums paid while unemployed
While the age requirement is the only restriction for withdrawals from a traditional IRA, Roth IRA distributions have an additional requirement. To make a qualified distribution from a Roth IRA, you must do so at least five years after the beginning of the first tax year in which a contribution was made. So if you opened your IRA and made your first contribution in 2020, you couldn’t make a qualified withdrawal until 2025, even if you had already reached age 59½.[5]
Early Withdrawals
In the situation of an early withdrawal, both traditional and Roth IRAs charge a 10% tax if you don’t meet one of the above withdrawal exceptions.
However, “the Roth IRA is better suited for early withdrawals because a Roth IRA allows someone to withdraw previous contributions without a penalty,” says L.J. Jones, a financial planner and the founder of Developing Financial.
Keep in mind that even with a Roth IRA, you still can’t withdraw your earnings without being subject to the 10% penalty. In the case of a traditional IRA, the penalty applies to both contributions and earnings.
Required Minimum Distributions
Certain retirement accounts have required minimum distributions (RMDs), where the IRS requires you to start withdrawing money by a certain age. Similar to a 401(k) plan, a traditional IRA requires that you start taking distributions by April 1 following the year in which you turn 72.[6]
But with a Roth IRA, there are no required minimum distributions, meaning you can leave the money in the account as long as you want. As a result, the Roth IRA is a popular savings tool for those who want to pass along an inheritance to the next generation.
“If an individual never wants to take a distribution in retirement, they can do that with a Roth IRA. A traditional IRA does not have this level of control,” says Jones. “Instead, it is subject to required minimum distributions, which force people to withdraw a certain amount from their traditional IRA or else owe a tax penalty.”
Should you choose a traditional or Roth IRA?
Choosing between a traditional IRA and a Roth IRA can be a difficult decision. The two accounts have very different tax benefits, so how do you know which is best for your situation?
“The decision on where to make your annual contributions can be based on several factors, such as one’s current income tax situation, projected annual income in retirement and assumed tax rates in retirement, to name a few,” says Lacroix.
Ultimately, the simplest way to decide between a traditional and a Roth IRA is to consider your tax rate. If you’re a high-income earner today with a high tax rate, you may prefer to contribute to a traditional IRA and enjoy the tax benefits today. Chances are, you’ll have a lower tax rate during retirement, meaning the tax savings are more beneficial now.
However, those in a lower tax rate today may find themselves in a higher tax rate at retirement. In that case, it might be better to choose a Roth IRA. You won’t get the reduced tax bill today, but you’ll enjoy tax-free distributions during retirement.
“When it comes to deciding between a traditional or a Roth IRA, it is important to note that the decision is not necessarily mutually exclusive,” says Lacroix. “Retirement savers can have both types of accounts and can amass both tax-deferred and tax-free savings over their lifetime.”
Where to open a traditional or Roth IRA
There are many options for where to open an IRA.
“IRAs can be opened through banks, other financial institutions, mutual fund companies, life insurance companies or through a stockbroker,” says Jones. “Since the accounts are similar, people should open an account where the fees are the lowest and where it is convenient for them to access.”