Roth IRA vs. Traditional IRA: Making the Right Choice

Saving for retirement is one of the best things you can do to enjoy a comfortable lifestyle after you bid farewell to the 9-to-5 – and it’s never too early to start.

You may know that some companies offer 401(k) plans to their employees to help them save for retirement, but there are other retirement plans to consider, like individual retirement accounts (IRAs).

IRAs are different from 401(k) plans, but we created this guide to explore IRAs, specifically the key differences between two types of IRAs: Roth IRAs and traditional IRAs. Are you wondering which one is best? We’ll outline the pros and cons of each retirement account to help you choose the right IRA for you.

Overview of Roth IRAs and Traditional IRAs

Individual retirement accounts (aka individual retirement arrangements) were created to help self-employed individuals build their retirement savings. But you can open an IRA account even if you have a 401(k). In fact, it may be a good idea to contribute to both.

While Roth IRAs and traditional IRAs share many similarities, there are several differences between them, too.

Here’s a quick overview of each IRA:

• Roth IRA: You contribute with after-tax dollars (aka your take-home pay). And because the money has already been taxed, it grows tax-free in your account, and you make tax-free withdrawals during retirement.
• Traditional IRA: You can contribute with after-tax or pre-tax dollars (aka taken out of your paycheck before taxes). Your money grows tax-deferred (think: your taxes are delayed) until retirement. Any withdrawals are taxed as income.

Let’s look at the differences between Roth IRAs and traditional IRAs.

Eligibility

Contributions

Withdrawals

Key Differences Between Roth IRAs and Traditional IRAs

Now that you have all the details, we’ll summarize the key differences between a Roth IRA and a traditional IRA to make it a little easier to digest.

Anyone with income can contribute to a Roth IRA and a traditional IRA, but if your MAGI (modified adjusted gross income) is over a certain amount, you won’t be able to contribute to a Roth IRA.

Remember, you can’t take advantage of a Roth IRA’s tax benefits until retirement. But you can take advantage of a traditional IRA’s tax benefits before retirement.

Roth IRAs offer more flexibility when it comes to making early withdrawals without paying penalties or taxes. You’re also never required to make a withdrawal, so your investment can sit untouched in your account for as long as you like.

With traditional IRAs, you’ll likely pay a penalty fee on early withdrawals, and they will probably be taxed. You are also required to take annual required minimum distributions (aka withdrawals) after age 72.

A tasty IRA analogy

To help you visualize how each IRA operates in retirement, let’s … bake a pie. (By the way, your retirement account is the pie!)

Whether it’s apple or butter coconut, all pies need ingredients. In this case, your ingredients are the money you’re stuffing into your pie.

This might be a controversial take, but the best part of making a pie is eating it. A Roth IRA is a delicious pie you made for your sole enjoyment. You don’t have to share your pie with anyone else once it’s out of the oven (read: after you retire). With a traditional IRA, you won’t get to enjoy the entire pie because you’ve invited friends over, and they’re all expecting a slice of your delicious pie.

Pros and Cons

A Roth IRA isn’t necessarily better than a traditional IRA. Depending on your current financial situation and your goals, either IRA can be a great option.

Let’s dive into the pros and cons of each one to help you better understand which one might work best for you.

Roth IRA pros and cons

Traditional IRA pros and cons

How To Choose the Right IRA

When it’s time to decide between a Roth IRA and a traditional IRA, keep all their pros and cons in mind. Then take a look at our list of considerations and factors that can also impact your decision:

• Timeline to retirement: Think about how long you’ll be making contributions, whether you need to make withdrawals in the near future and what your tax bracket may be when you retire.
• How you want to contribute: Do you want to start with larger contributions and then slowly reduce them? Or do you want to contribute a steady amount over time? This can affect the taxes you pay and when you pay them.
• Access to emergency funds: Because Roth IRA contributions can be withdrawn tax-free and penalty-free at any point, you can use your account as a secondary emergency savings account for larger expenses your emergency fund can’t cover. This makes a Roth IRA a better option than a traditional IRA, especially if your income isn’t consistent.
• Diversifying your investments: Many traditional IRA tax benefits are similar to benefits for 401(k) plans. If you want to diversify your investments and have a 401(k), a Roth IRA may be a wiser money move than a traditional IRA.
• Account management: Do you want to manage your IRA or have a brokerage manage it?
• Fees and minimums: When you’re choosing between brokerages or different IRA accounts offered, look for fees, like account fees or advisory fees. You should also confirm if a minimum deposit is required to open an account.

From IR-Ehh to IR-Yay

When you’re deciding between a Roth or traditional IRA, answer this question: When do I need to take advantage of the account’s tax break?

Is it now when you’re an assistant, but you’re making a beeline to the C-suite? Remember, Roth IRA contributions are made with after-tax dollars, and you can make tax-free withdrawals.

Or will you need to take advantage of the tax break later because you’ve climbed the corporate ladder and your search for work-life balance has led you to take on smaller consulting gigs? Remember, traditional IRA contributions can be deducted from your taxes, and you pay taxes when you withdraw your money.

It’s a big decision you don’t have to make alone. Recruit a financial advisor to help you make the best decision for you and your present and future finances.