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Roth vs Traditional IRAs: Which Is Right for You?
Both Roth and traditional IRAs may help you save for retirement, but they have a few differences.
When it comes to saving for retirement, you may assume the only option you have is opening a 401(k) through your employer. Luckily, this isn’t the case.
Another option for retirement planning is an individual retirement account (IRA). You may open an IRA at any time to start or further maximize your retirement savings and help you plan for your future.
There are two main types of IRAs: Roth and traditional. Let’s look at the differences between the types and how each impacts your retirement savings.
This information is not tax or investment advice. You should consult with a tax advisor and/or a qualified investment professional for advice specific to your particular circumstances.
Key Takeaways
IRAs may help you establish your retirement savings or maximize these efforts when used in conjunction with a 401(k) account.
Traditional IRAs are available to anyone regardless of income, while Roth IRAs have income limits.
Traditional IRAs offer a tax break in the near term while Roth IRAs have you pay taxes now but allow you to withdraw funds tax-free when you reach retirement age.
IRA Overview
Before we dive into the differences between Roth and traditional IRAs, let’s take a quick look at how individual retirement accounts work.
Similar to 401(k) accounts, IRAs may help you save for retirement and potentially grow your money through investments. IRAs also tend to offer a wider variety of investment options than 401(k) plans. Since IRAs are separate from your 401(k), you may be able to contribute to both an IRA and 401(k) in the same year.
Opening an IRA could be helpful, even if you have a 401(k), for a variety of reasons. First, if you’re on track to max out your 401(k) contributions but want to save more that year, you could add to your IRA too. Leveraging the IRA as a tool may help you close a gap in your retirement savings or just get a little further ahead.
Additionally, if you leave your job, you may want to take your retirement with you. Many plans allow you to roll 401(k) funds into an IRA, so having an IRA account already in place could come in handy!
Of course, IRAs may also be your main retirement savings vehicle if you don’t have an employer-sponsored retirement account to lean on. Since your IRA is tied to you, not your employer, you’re able to continue contributing to the account throughout a lifetime of job changes.
As you might expect, the IRS places contribution limits on IRA accounts. For 2024, the limits are $7,000 per year if you’re under 50 years old and $8,000 if you’re 50 and older.1
Also keep an eye out for account management fees and investment management fees, as these could reduce your overall earnings.
Traditional vs Roth IRAs: What’s the Difference?
There are a few fundamental differences between Roth and traditional IRAs that impact which account you may choose to open.
IRA Eligibility
In order to open an IRA, the account owner must have earned income from a full time job, self-employment, or a part-time job. Consult with a financial advisor to determine if you, or your spouse, is eligible to open an IRA.
Additionally, non-working spouses may open a spousal IRA and contribute up to the contribution limit each year provided they file a joint tax return, and their partner earns enough income to cover the contributions to the spousal IRA.2
Your income determines which kind of IRA you’re able to contribute to. Roth IRAs have income limits in place that vary depending on your filing status and modified adjusted gross income (MAGI). These limits restrict who is able to directly contribute to a Roth IRA.3 On the other hand, traditional IRAs don’t have contribution restrictions based on income.4
If your MAGI is over the following limits, you’re unable to contribute to a Roth IRA in 2024:5
Filing Status | Income Limit |
|---|---|
Married filing jointly or qualifying widow(er) | Equal to or less than $240,000 |
Married filing separately and you lived with your spouse during the year | Equal to or less than $10,000 |
Single, head of household, or married filing separately and you did not live with your spouse during the year | Equal to or less than $161,000 |
How Contributing to an IRA Impacts Your Taxes
Contributions to traditional IRAs and Roth IRAs offer different benefits and work in different ways as far as your taxes are concerned.
When you contribute to a traditional IRA, you’re contributing pre-tax dollars to the account. This means you may be able to deduct your contributions from your adjusted gross income at the end of the year when you file.
What does this mean for you? By contributing your pre-tax dollars, you’re effectively using the government’s money to invest in your retirement fund—in other words, you may earn money on the money you would’ve otherwise paid in taxes. It’s important to consider your current and likely future tax brackets (and consult a tax professional) to help you make a decision between the accounts.
That said, the government won’t let you keep their money forever! A traditional IRA requires you to pay income taxes on your retirement distributions. If you’re in a higher tax bracket at that stage of life, you may end up paying more income tax on the funds than you would have paid at the time of investment.
When you contribute to a Roth IRA, you’re contributing post-tax dollars. This means you’re paying tax upfront on each contribution you make. The upside to paying the taxes upfront is you won’t owe taxes on any money the account earns. When you withdraw these funds later on, they aren’t considered income and don’t affect your tax liability.
Keep in mind that the contribution limit applies to the total contributions for all of your IRAs. If you have a Roth and a traditional IRA, you’re only able to contribute a maximum of $7,000 or $8,000 per year, depending on your age, between the accounts.6
Withdrawing from IRAs
As with 401(k) retirement accounts, there are rules in place for how and when you access the money you keep in your IRA and when you’re allowed to start withdrawing funds. Those rules differ for traditional and Roth IRAs.
Withdrawing from a Traditional IRA
Funds in a traditional IRA may be withdrawn at any time, whether they’re contributions or earnings. Regardless of your age when you withdraw, these funds are taxed as income.
However, if these funds are withdrawn before you’re 59 ½, an additional 10% penalty is charged unless the funds are used for specific purposes, such as using funds for qualified higher education expenses or certain medical expenses.7
Additionally, traditional IRAs require you to take minimum distributions once you turn 73.
Withdrawing from a Roth IRA
Similar to a traditional IRA, contributions may be withdrawn from a Roth IRA at any time. However, earnings may not be withdrawn until the account has been open for five years. If you withdraw earnings before you’ve reached that five-year mark, you may have to pay a penalty.8
For example, say you’re 36 and you’ve contributed $20,000 over a 4-year period to your Roth IRA. If the account is worth $55,000 due to investments, you’re still only able to withdraw $20,000 from the account because the other $35,000 is considered earnings.
While withdrawals aren’t subject to income tax, if they’re made before you turn 59 ½ you may owe a 10% penalty unless the funds are used for qualified reasons, such as buying your first home, or the account owner has become permanently disabled.9
If you wait until 59 ½ to withdraw funds from a Roth IRA, you’re able to make tax-free withdrawals from the account. Furthermore, Roth IRAs don’t have required minimum distributions once you turn 73, meaning you are able to let your money continue growing if you don’t need it yet.
Consult with a tax professional for advice on your specific withdrawal situation.
Which IRA Type Is Right
If you qualify for both types of IRAs, choosing between a traditional and a Roth IRA is largely a matter of personal preference. You may want to consider two key factors before you make your decision, but it’s always smart to consult with a professional to help you make the best choice for your situation.
Does Income Exceed Limits?
Your income is probably the biggest factor to keep in mind when choosing between a Roth and traditional IRA.
While anyone is able to open a Roth or traditional IRA, contributing is a different matter. If your income exceeds the IRS’ limits for Roth IRAs, you’re only able to make direct contributions to a traditional IRA. However, if you want to take advantage of the Roth IRAs’ tax-free growth on earnings, you do have the option to convert a traditional IRA into a Roth IRA. This is sometimes called a “backdoor Roth”.
If you’re considering a backdoor Roth conversion, consult a financial advisor to determine how this may impact your taxes.
How Could Tax Brackets Change?
If you think your tax bracket may be higher in the future, a Roth IRA may be the better choice. Your contributions are made on a post-tax basis, meaning you’re paying taxes upfront at your current tax bracket’s rate. If your tax bracket goes up in retirement and you’ve chosen a traditional IRA, you may end up paying more in taxes in the long run once you start withdrawing funds.
If you think your tax bracket may be lower, a traditional IRA may lower your tax burden in the short term. You still pay taxes once you start making withdrawals, but that rate may be the same or lower than it is right now. A traditional IRA may also help you free up cash in the short term since you’re not paying taxes on your contributions.
Final Thoughts
Both traditional and Roth IRAs could help you save for retirement and may be used in conjunction with a 401(k) account.
Since both accounts offer different tax benefits, you want to carefully consider your options and speak with your financial advisor or tax professional to determine which account best serves your needs.
Already maxed out your IRA and 401(k)? Or just need a little more flexibility with your cash? Learn how choosing the right savings account could help you start building your wealth with confidence.