The Individual Retirement Account (IRA) is one of the most common retirement planning accounts, and for good reason. All IRAs offer self-directed investment opportunities and can come with significant tax benefits.
The two main IRAs used for retirement planning are the Roth IRA and the Traditional IRA. Here’s how they’re different, and which might be the preferable option for you.
Understanding IRAs
IRAs are tax-advantaged retirement accounts designed to encourage saving and investing for retirement. They allow your investments to grow either tax-deferred or tax-free, depending on the type of account you choose. It’s the tax benefits that particularly make these a go-to retirement savings account for many individuals and couples.
Both Roth and Traditional IRAs are supported by a wide range of investment options including stocks, bonds, mutual funds, and ETFs. As you make contributions throughout your working years, your investments have the potential to grow.
These accounts give you control over your retirement savings — and can play an instrumental role in financially preparing for your non-working years.
The Roth IRA Explained
A Roth IRA offers the opportunity for tax-free growth and tax-free withdrawals in retirement. The Roth has future tax benefits, in other words.
Contributions to a Roth IRA are made with after-tax dollars, meaning they are not tax-deductible at the time of contribution. You’ll pay taxes at your current income tax rate (federal and state) when making contributions to a Roth IRA.
Growth in the account isn’t taxed, however, and qualified withdrawals in retirement (after age 59 ½ and at least five years after the account was opened) aren’t taxed either. Qualified withdrawals in retirement, including both contributions and earnings, are completely tax-free.
Tax-free growth can yield a large income tax savings if you’re investing for any significant amount of time. You also could avoid higher tax rates if they’re increased in the future (unknown).
The Traditional IRA Explained
In contrast, a Traditional IRA may provide an immediate tax benefit. Contributions may be untaxed, in which case you could take advantage of tax-deferred growth until retirement.
Contributions to a Traditional IRA are often tax-deductible when they’re made. Whether you can deduct contributions depends your income, and whether you or your spouse are covered by a retirement plan at work. Many people can claim the tax deduction when contributing to a Traditional.
Withdrawals are taxed as ordinary income when they’re taken, meaning that you’ll ultimately pay income tax on both contributions and growth. Deferring taxes until your retirement years may provide two distinct benefits, though.
First, you’ll likely have a larger basis to invest. Successfully investing a larger amount might yield you a bigger nest egg in retirement. Second, many people are in a lower income tax bracket during retirement. You’re taxed at the applicable rate when you take withdrawals.
(Investments carry risk, and it’s not guaranteed that your nest egg will grow.)
Key Differences Between Roth and Traditional IRAs
While tax treatment is the biggest difference between Roth and Traditional IRAs, it’s not the only one. Any or several of these might have an impact on whether a Roth or Traditional would be better for you.
Tax Treatment
With a Roth IRA, you pay taxes upfront, allowing your investments to grow and be withdrawn tax-free. With a Traditional IRA, you potentially receive a tax deduction on your contributions and defer taxes until you make withdrawals, at which point the distributions are taxed as ordinary income.
Eligibility Requirements
Both Roth IRAs and Traditional IRAs have annual contribution limits based on your age. The maximum contribution for 2024 is $7,000 if you’re under 50, or $8,000 if you’re 50 or older. Many retirement plans have an additional “catch-up” allowance once you’re 50.
There is no income restriction for a Traditional IRA. You normally can contribute the full $7,000 or $8,000 to a Traditional IRA regardless of how much you make.
Roth IRA is subject to an income restriction. You won’t be able to fully participate in a Roth IRA if you’re above a certain income level. It’s a progressive phasing out, so you might have a lowered contribution limit or not be able to contribute at all. The phasing depends on your tax filing status, income, and age.
| Filing Individually | Married Filing Jointly | Married Filing Separately | Maximum Contribution for individuals under age 50 | Maximum Contribution for individuals age 50 and older |
| under $146,000 | under $230,000 | $0 | $7,000 | $8,000 |
| $147,500 | $231,000 | $0 | $6,300 | $7,200 |
| $149,000 | $232,000 | $0 | $5,600 | $6,400 |
| $150,500 | $233,000 | $0 | $4,900 | $5,600 |
| $152,500 | $234,000 | $0 | $4,200 | $4,800 |
| $153,500 | $235,000 | $0 | $3,500 | $4,000 |
| $155,000 | $236,000 | $0 | $2,800 | $3,200 |
| $156,500 | $237,000 | $0 | $2,100 | $2,400 |
| $158,000 | $238,000 | $0 | $1,400 | $1,600 |
| $159,500 | $239,000 | $0 | $700 | $800 |
| $161,000 & over | $240,000 & over | $10,000 & over | $0 | $0 |
If you’re above these income limits and still want to utilize a Roth IRA, a financial advisor might be able to execute a “backdoor Roth IRA.” This is a strategy wherein high earners contribute to a Traditional IRA but pay taxes on the contributions. An advisor may then be able to roll over the Traditional IRA to a Roth one.
Backdoor Roth IRAs are a somewhat complex financial strategy, and it’s important to make sure they’re executed properly. It’s recommended that anyone considering this option speak with a knowledgeable financial advisor.
Withdrawal Rules
1. Allowed Withdrawals
Both options are subject to withdrawal restrictions, but Roth IRAs offer greater flexibility in this regard. Should you withdraw from either for an unallowed reason, you may be subject to a 10% penalty plus taxes.
Withdrawals can be taken from a Roth IRA or Traditional IRA starting at age 59½, regardless of whether you’re still working.
Roth IRAs allow for withdrawing in certain other situations before you’re 59½. You may be able to withdraw up to $10,000 for a first-time home purchase, and you may be able to make withdrawals if you become disabled.
Should disaster strike within 5 years of opening a Roth IRA, contributions usually can be withdrawn to help cope with certain educational expenses, birth/adoption expenses, disaster recovery expenses, restarting expenses after domestic abuse, and outstanding IRS levies. Withdrawing for permitted reasons like these may avoid the 10% penalty, but taxes usually must still be paid.
Traditional IRAs generally don’t have the same provisions as Roth IRAs. Withdrawing for any reason before age 59½ will likely incur a 10% penalty if you have a Traditional one.
2. Mandatory Minimum Withdrawals
Traditional IRAs have a required minimum distribution (RMD) that’s triggered once you turn 73. You must take an RMD by April 1 of the year after you turn 73, and then by December 31 of every following year. Not taking an RMD could incur a 10% or 25% excise tax.
Your RMD is calculated by dividing your Traditional IRA’s value by your life expectancy (as determined by the IRS). A financial advisor can calculate this for you, and withdrawing more at this age is always allowed.
Any Roth IRA you open won’t be subject to RMDs. Withdrawal requirements can be triggered if you receive a Roth IRA from a spouse, another family member, or in select other situations.
| Feature | Roth IRA | Traditional IRA |
| Tax Treatment of Contributions | No tax deduction | Tax-deductible (subject to income limits) |
| Tax Treatment of Withdrawals | Tax-free (qualified) | Taxed as ordinary income |
| Income Limits | Yes (contribution limit phase-out based on MAGI) | Yes (only for deductions) |
| Contribution Limits (2024) | $7,000 (under 50), $8,000 (50 or older) | $7,000 (under 50), $8,000 (50 or older) |
| Required Minimum Distributions (RMDs) | No | Yes (starting at age 73) |
Choosing the Right IRA for You
Selecting the right IRA depends on your current financial situation, your tax bracket now versus expected tax bracket in retirement, and your investment horizon.
A Roth IRA may be more suitable if you anticipate higher taxes in the future or prefer the flexibility of tax-free withdrawals. A Traditional IRA might be the better choice if you seek an immediate tax deduction and expect lower taxes in retirement.
These are only very broad and general guidelines, as there are other details to consider. Choosing which one is right for you ultimately requires a comprehensive evaluation.
Consult with a Financial Advisor for In-Depth Retirement Planning
Choosing the right type of IRA is a critical step, but it’s just one piece of the retirement planning puzzle. You also need to determine how much to save, evaluate your employer’s retirement plan options, and create a comprehensive strategy that aligns with your goals.
If you’re feeling overwhelmed or unsure about the best path forward, don’t hesitate to seek professional guidance. Our team of experienced financial advisors at Invested Better is ready to help. We can provide personalized advice on IRAs, retirement planning, and all aspects of your financial journey. Get matched with a financial advisor today and take the first step towards a fulfilling retirement.
