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Roth IRA vs. Traditional IRA: Making the Right Choice

TLDR

What You Need To Know

  • Traditional IRA contributions can be deducted from your taxes, and you pay taxes when you withdraw your money
  • Roth IRA contributions are made with after-tax dollars, and you can make tax-free withdrawals
  • You can choose when you want to make withdrawals with a Roth IRA, but with a traditional IRA, you must take a required minimum distribution every year after age 72

Contents

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

Select a tab to see related data:
  • Roth IRA
  • Traditional IRA
Roth IRA Traditional IRA
Age Limit

None (If you’re under 18, you must have an adult account custodian.)

None (If you’re under 18, you must have an adult account custodian.)
Income Requirements
  • Anyone with income can contribute.
  • Ineligible if your modified adjusted gross income (MAGI) is over:
    • $144,000 and you’re single or married filing separately and don’t live with your spouse
    • $10,000 and you’re married filing separately and live with your spouse
    • $214,000 and you’re married and filing jointly
  • Check the IRS website for more income limitations
Anyone with income can contribute. There are no income restrictions.[1]

Contributions

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  • Roth IRA
  • Traditional IRA
Roth IRA Traditional IRA
IRA Contribution Limit for 2022 Tax Year[2]
  • $6,000 ($7,000 if you’re over 50)
  • If your income for the year is below the limit above, you can’t contribute more than you make.
  • $6,000 ($7,000 if you’re over 50)
  • If your contributions are less than the above, they can’t exceed your income earned that year.
Tax Deductions[3] No annual tax deductions Annual tax deductions for some or all of your contributions (limited if you or your spouse contributes to an employer-sponsored retirement plan).

Withdrawals

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  • Roth IRA
  • Traditional IRA
Roth IRA Traditional IRA
Required Minimum Distribution (RMD)[1] None Annual RMD after age 72
Early Withdrawal Penalty[1]
  • 10% federal penalty tax on earnings and contributions withdrawn before age 59 ½ (there are some exceptions).
  • No penalty for withdrawing contributions.
10% federal penalty tax on earnings and contributions withdrawn before age 59 ½ (there are some exceptions).
Earnings Can be withdrawn tax-free: Taxed before and during retirement
Contributions Can be withdrawn tax-free before and during retirement.[4] Taxed:
  • Before retirement if you deducted them in your taxes.
  • During retirement

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

PROS of a Roth IRA👍

Penalty-free and tax-free contribution withdrawals

While your earnings may be subject to taxes and penalties if withdrawn early, you can make penalty-free and tax-free withdrawals on your contributions.

Withdraw earnings tax-free during retirement

One of the biggest benefits of a Roth IRA is that, unlike traditional IRAs, you can withdraw your earnings tax-free during retirement.

No withdrawal requirement

The longer your money sits in your IRA, the more it earns. And you may want to keep it until you need it. Unlike traditional IRAs, you are not required to withdraw money from your Roth IRA.

CONS of a Roth IRA👎

No tax benefits upfront

Because you’re contributing money to a Roth IRA with after-tax dollars, you can’t deduct your contributions from your taxes. Your Roth IRA tax benefits are enjoyed during retirement.

Temptation to withdraw at any time

Making tax-free and penalty-free withdrawals whenever you want to is a plus, but continuously dipping into your reserves before retirement with no plans to replenish your account will leave you with a smaller nest egg during retirement.

Traditional IRA pros and cons

PROS of a Traditional IRA👍

Tax deduction benefits

One of the biggest benefits of traditional IRAs is the upfront tax break you get that allows you to deduct some or all your annual contributions on your tax return. It can lower the amount of taxes you owe and provide financial relief upfront.

Only pay taxes when you withdraw

Unlike Roth IRAs, you don’t pay taxes on contributions for traditional IRAs. This can be a huge plus if you anticipate being in the same or lower tax bracket when you retire. With a traditional IRA, you may be able to enjoy more of your contributions and earnings because you’ll be taxed less during retirement.

CONS of a Traditional IRA👎

Withdrawals are taxed

Tax deductions on your contributions may benefit you in the short-term, but the taxes you pay on withdrawals during retirement will cut into your savings. And if you’re in a higher tax bracket when you retire, you may end up paying more in taxes than if you had a Roth IRA.

Early withdrawal fees

You will pay a fee for early withdrawals unless it’s a qualified distribution.

Required to withdraw money starting at age 72

You can choose when you want to make withdrawals with a Roth IRA, but with a traditional IRA, you must take a minimum distribution every year after age 72.

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.

  1. Internal Revenue Service. “Traditional and Roth IRAs.” Retrieved October 2022 from https://www.irs.gov/retirement-plans/traditional-and-roth-iras

  2. Internal Revenue Service. “Retirement Topics – IRA Contribution Limits.” Retrieved October 2022 from https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits

  3. Internal Revenue Service. “IRA Deduction Limits.” Retrieved October 2022 from https://www.irs.gov/retirement-plans/ira-deduction-limits

  4. Internal Revenue Service. “Publication 590-B: Distributions from Individual Retirement Arrangements (IRAs).” Retrieved October 2022 from https://www.irs.gov/pub/irs-pdf/p590b.pdf

ICYMI

In Case You Missed It

  1. You can open an IRA account even if you have a 401(k)

  2. Anyone with income can contribute to Roth IRAs and traditional IRAs, but if your income is over a certain amount, you can’t contribute to a Roth IRA

  3. One of the biggest benefits of a Roth IRA is that, unlike traditional IRAs, you can withdraw your earnings tax-free during retirement

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