Roth IRA Vs. Traditional IRA: Which Is Right For You?

The sooner you’re able to start planning for retirement, the better off you’ll be. With the power of consistent savings and market growth, you can set yourself up for a comfortable retirement.

Among the various individual retirement account options, Roth IRAs and traditional IRAs are popular choices. Understanding the difference between the two is key to making a sound financial decision that will pave the way for a more secure future.

Understanding Traditional IRAs And Roth IRAs

Traditional individual retirement accounts (IRAs) and Roth IRAs are two of the most favored types of retirement plans. They both provide opportunities for individuals to save for retirement, with specific tax benefits. However, they’re distinct from a 401(k), primarily because IRAs are set up by individuals themselves, while 401(k)s are employer-sponsored retirement plans.

• Traditional IRA: A traditional IRA allows contributions to be a full or partial deduction from your income, meaning that they lower your overall taxable income. Over time, these contributions experience tax-deferred growth. However, distributions from your IRA will be taxed when you withdraw in retirement.
• Roth IRA: With a Roth IRA, you make contributions with post-tax dollars, meaning your income has already been taxed before allocating dollars to the account. Once you are eligible to withdraw in retirement, your distributions are tax-free.

It’s also worth noting that an individual can have and contribute to both a 401(k) or other employer-sponsored retirement account and an IRA during the same year to maximize their tax benefits.

Differences Between Roth And Traditional IRAs

Traditional IRAs and Roth IRAs offer unique benefits, but they differ in several key areas, such as eligibility requirements, tax structures, contribution limits, withdrawal rules and minimum distributions.

Let’s compare these two account types to help you decide what works best for you.

Eligibility Requirements

Traditional and Roth IRAs differ notably when it comes to income restrictions. For traditional IRAs, there's no cap on your annual income to be eligible to contribute; you (or your spouse, if filing jointly) can open and contribute to a traditional IRA as long as you have earned income.

Roth IRAs, on the other hand, have an annual income cap for higher earners. The exact income limits depend on your tax filing status – whether you're single, married filing jointly or married filing separately. For instance, if you're single and your income surpasses a certain threshold, you won't be eligible to contribute to a Roth IRA. For married couples, the limits are higher, allowing more room for contributions.

The specific income thresholds are updated annually by the Internal Revenue Service (IRS), so it's critical to check the most recent guidelines.

Taxes

In a traditional IRA, the money you contribute may be deducted from your taxable income in the year you make the contribution. However, there is a catch, when the time comes for you to withdraw your money, your distributions will be taxed as ordinary income.

Contributions to a Roth IRA are made with money you pay taxes on that same year, but you don't get any tax deductions for contributions. However, when you withdraw your funds, your initial investments and any profits can be withdrawn tax-free. This can be a large benefit to Roth IRAs over Traditional IRAs because earnings are not taxed.

Contribution Limits

When we talk about contributions to IRAs, we're referring to the money you put into these accounts from your income. These contributions are capped each year, with specific limits set by the IRS.

For 2024, both traditional and Roth IRA accounts have a maximum contribution limit of $7,000. If you're age 50 or over, you can make an additional “catch-up” contribution of $1,000, raising the total limit to $8,000.

More specifically, with Roth IRAs, if you're married and filing jointly, and your income is over a certain threshold, your contribution limit might be reduced, or you may not be able to contribute at all. In 2024, the maximum income limit if filing single is $161,000 and $240,000 if married, filing jointly.

Withdrawal Rules

When it comes to both types of IRAs, there's a specific age to remember: 59½. That’s when you can start withdrawing funds from your IRA without incurring penalties, regardless of if you’re actually retired or not.

For traditional IRAs, if you withdraw funds before reaching this age, you'll usually face a 10% early withdrawal penalty and have to pay income tax on the amount withdrawn. However, there are certain exceptions to this rule, such as using the funds for a first-time home purchase or certain medical expenses.

On the other hand, Roth IRAs offer a bit more flexibility when it comes to withdrawals. Since you've already paid taxes on the money you've contributed, you can withdraw these contributions at any time without penalty. However, it's a different story if you try to withdraw any earnings (the money your contributions have made) before you reach age 59½, as you’ll likely pay a 10% penalty. 

Required Minimum Distributions

Once you reach age 72, traditional IRAs have a requirement that you must start taking withdrawals from your account. These are called required minimum distributions (RMDs), or the minimum amount you must withdraw from your account each year.

With a traditional IRA, this requirement is based on the IRS's life expectancy tables, and it's designed to ensure that you don't simply accumulate a tax-deferred retirement account without ever taking distributions. These withdrawals are then taxed as regular income.

On the flip side, Roth IRAs don’t have any RMDs during the account owner's lifetime. This makes Roth IRAs a great tool, as you can let the money in your account grow tax-free for your entire life.

Other Benefits

Apart from their primary function as retirement saving vehicles, both traditional and Roth IRAs come with additional benefits that can be valuable in different stages of life.

For example, with a traditional IRA, you can withdraw money to pay for qualified college expenses without facing the typical early distribution penalty. This could be a lifesaver when it comes to managing tuition and other college-related costs. Another perk is that you're allowed to use up to $10,000 toward the purchase of your first home without incurring a penalty.

A Roth IRA offers similar benefits, as you can also use up to $10,000 toward a first-time home purchase. However, there's a catch: you must have had the Roth IRA for at least 5 years to qualify for this benefit. This might seem like a hurdle, but it's worth keeping in mind that with the Roth IRA, you're also getting tax-free growth and withdrawals in retirement.

The Pros And The Cons Of Traditional Vs. Roth IRAs

As you weigh the differences between traditional and Roth IRAs, let's take a closer look at their respective pros and cons.

Traditional IRA

Pros

• Tax deductions: Your contributions to a traditional IRA may be tax-deductible, reducing your taxable income for the year.
• No income limits: Regardless of how much you earn, you can contribute to a traditional IRA. This makes it accessible to high-income individuals.
• Can be used to pay for a first home: Up to $10,000 can be withdrawn for a first home purchase without an early distribution penalty.
• Can be used to pay for college: You can also use funds to pay for qualified higher education expenses without facing an early withdrawal penalty.

Cons

• Early withdrawal penalty: If you withdraw money from your traditional IRA before you reach age 59½, not only will you have to pay regular income tax on your withdrawal, but also an additional 10% early withdrawal penalty.
• Potentially more taxes: Since withdrawals from a traditional IRA are taxed as regular income, you could end up paying more taxes if you're in a higher tax bracket when you retire.
• Mandated distributions: Once you hit age 72, you must start taking minimum distributions from your traditional IRA, even if you don't need the money. This could potentially bump you into a higher tax bracket.

Roth IRA

Pros

• Taxes paid upfront: For a Roth IRA, the money you put in is taxed before it enters your account. This means the contributions are made with post-tax dollars, allowing you to take out all the money – including any profits – tax-free at the time of withdrawal.
• No minimum distributions: Roth IRAs don’t require any withdrawals during the lifetime of the account holder. This allows your money to grow tax-free for as long as you like.
• Withdraw contributions penalty-free: You can take out your contributions at any time, without penalty, after 5 years with the account. However, withdrawing earnings may lead to penalties and taxes.
• Flexibility for beneficiaries: Roth IRAs offer the advantage of tax-free growth and tax-free withdrawals for your beneficiaries, which can be a significant advantage if you intend to leave your IRA to your family.

Cons

• Income limit: Higher-income individuals may not be able to contribute to a Roth IRA or have reduced contribution limits.
• Maximum contribution limit: The contribution limit for 2024 is $7,000 for those under 50, and $8,000 for those 50 and older.
• No tax deduction: Contributions to a Roth IRA aren’t tax-deductible, which means you won't receive an immediate tax benefit for your contributions. This can be a disadvantage for individuals seeking to lower their taxable income in the present.
• 5-year rule: This rule stipulates that you must wait at least 5 years after your initial contribution before you can make tax-free and penalty-free withdrawals of contributions, even if you've reached the age of 59½.

How To Choose The Right IRA For You

1. Check Eligibility

As of 2024, income is the most important factor when considering eligibility. There’s no specific age or additional retirement plan that affects your eligibility.

A traditional IRA doesn’t have an income cap. On the other hand, if you (or your spouse, if filing jointly) make more than the annual maximum, you won’t qualify for a Roth IRA. For 2024, single filers must not earn more than $161,000 and those who are married and file jointly must not earn more than $240,000.

2. Anticipate Your Future Income

The next thing to consider is your future income tax bracket. If you have many years before retirement, it can be hard to know exactly what your tax bracket will be 40 or 50 years down the road. However, there is a general rule to help you make the best decision:

Traditional IRAs: The upfront tax deduction can be beneficial now, and if you anticipate being in a lower tax bracket when you retire than you are now, this can be a smart choice.

Roth IRA: If you anticipate being in a higher tax bracket when you retire, then the tax-free withdrawals can be beneficial and this may be a better choice for you.

3. Work With A Brokerage

To start either a traditional or Roth IRA, you'll need to work with a brokerage firm or platform. There are many different options ranging from platforms that allow you to self-manage your investments, to a robo-advisor or a full-service brokerage. When selecting a brokerage firm or platform, make sure they offer a Traditional or Roth IRA as an investment account option.

FAQs About Roth And Traditional IRAs

The idea of investing for retirement can be intimidating, here are some frequently asked questions to get you started.

Is a 401(k), traditional IRA or Roth IRA better?

Deciding between a 401(k), traditional IRA, or Roth IRA largely depends on your individual financial circumstances and future tax expectations.

A 401(k) often includes an employer match, which is essentially free money so long as you contribute to the account, while a traditional IRA offers tax deductions now with tax on withdrawals later. A Roth IRA requires you to pay taxes upfront but allows for tax-free withdrawals in retirement. That said, you don’t necessarily have to choose -- you can contribute to both a 401(k) and an IRA in the same year to maximize your savings.

Which is better for married couples, a traditional or Roth IRA?

For married couples, the choice between a traditional or Roth IRA depends on their combined income, current tax bracket and projected retirement income. If the couple anticipates being in a higher tax bracket during retirement, a Roth IRA – with its tax-free withdrawals – may be a better choice. Conversely, if they expect to be in a lower tax bracket upon retirement, a traditional IRA might make more sense.

Can I contribute to both a traditional IRA and a Roth IRA?

Yes, you can contribute to both a traditional IRA and a Roth IRA in the same tax year, as long as your total contributions do not exceed the annual limit set by the IRS ($7,000 or $8,000 if you’re age 50 or older, as of 2024).  

What is a backdoor Roth IRA?

The term "backdoor Roth IRA” refers to an advanced strategy used by high-income earners who are usually ineligible for a Roth IRA due to income limits. In this method, individuals first make a non-deductible contribution to a traditional IRA, then convert the contribution funds to a Roth IRA. This strategy allows them to benefit from the tax-free growth and withdrawals offered by Roth IRAs. We recommend speaking to a financial advisor if you are interested in this strategy.

The Bottom Line

Both a traditional IRA and a Roth IRA can be great options to save for retirement. No matter which you choose, the sooner you start investing, the better off you'll be in retirement.

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