Roth IRA vs Traditional IRA: 5 Key Differences and How to Choose the Best Option

Roth IRA vs Traditional IRA

Whether you’re a new college graduate or an established professional, it’s never too early to start planning for your retirement. As one might expect, the longer you live, the more resources you’ll need to sustain your lifestyle, so it’s always a good idea to start saving sooner rather than later.

When saving money for your retirement, there are two common types of individual retirement accounts (IRA) that you can invest in: a Roth IRA and a traditional IRA. When reviewing some of their key differences, it’s important to ask yourself: “What’s the difference between a Roth IRA vs Traditional IRA?”

What is a Roth IRA?

A Roth IRA is a special type of retirement account where contributions are made with after-tax dollars. This means that the money you invest in a Roth IRA has already been taxed, and therefore, it won’t be taxed again when you withdraw it in retirement.

Here’s a closer look at some key features of a Roth IRA:

  • Tax-Free Growth: One of the most appealing aspects of a Roth IRA is that your investments grow tax-free. Any gains from your investments, whether from interest, dividends, or capital gains, are not subject to taxes as long as they remain in the account.
  • Tax-Free Withdrawals: When you reach retirement age (59½ or older) and have held the account for at least five years, you can withdraw your contributions and earnings tax-free. This can provide substantial tax savings during your retirement years.
  • Contribution Limits: Per the IRS, the annual contribution limit for IRAs has increased to $7,000 for 2024, up from $6,500 in 2023. For those aged 50 and over, the catch-up contribution limit remains at $1,000, bringing the total allowable contribution to $8,000 for eligible individuals.
  • Income Limits: Eligibility to contribute to a Roth IRA is subject to income limits. For 2024, the ability to contribute starts to phase out at a modified adjusted gross income (MAGI) of $138,000 for single filers and $218,000 for married couples filing jointly. If your income exceeds these limits, your contribution limit may be reduced or eliminated.

What is a Traditional IRA?

A Traditional IRA is a type of retirement savings account that offers tax advantages for individuals looking to save for their retirement. Contributions to a Traditional IRA are typically tax-deductible, which means you can deduct the amount you contribute from your taxable income for the year, potentially lowering your current tax bill.

Here’s a breakdown of some key features of a Traditional IRA:

  • Tax-Deferred Growth: Investments in a Traditional IRA grow tax-deferred. This means you won’t pay taxes on the earnings from your investments until you withdraw the money in retirement. This allows your investments to potentially grow more quickly, as they are not being reduced by taxes each year.
  • Taxable Withdrawals: When you withdraw money from a Traditional IRA in retirement, those withdrawals are subject to income tax. This includes both your contributions and any earnings on those contributions.
  • Contribution Limits: According to the IRS, the maximum annual contribution limit for IRAs has increased to $7,000, up from $6,500 in 2023. For individuals aged 50 and over, the catch-up contribution limit remains at $1,000, making the total contribution limit $8,000 for those eligible.
  • Required Minimum Distributions (RMDs): Starting at age 73, you are required to begin taking minimum distributions from your Traditional IRA each year. These RMDs are based on your account balance and life expectancy and are subject to income tax.
  • Eligibility: There are no income limits for contributing to a Traditional IRA. However, whether your contribution is tax-deductible can depend on your income and whether you or your spouse is covered by a retirement plan at work.

Roth IRA vs Traditional IRA: 5 Key Differences

You may think the term “Roth” is an acronym for a complex financial term, but that’s surprisingly not the case. The origin of “Roth” comes from William Roth, a Delaware senator when the Roth IRA was established by the Taxpayer Relief Act in 1997.

When beginning the decision-making process, it’s important to determine how you prefer your contributions to be made. Contributions to a Roth IRA are never deductible; they are made with after-tax dollars. This affects the amount of investment income you will make because your investments grow tax-free, and withdrawals in retirement are also tax-free.

Considering the tax implications of a Roth IRA, think about whether your tax rate during retirement will be higher or lower than your current tax rate. With a Roth IRA, you pay taxes now at your current rate, rather than later at your retirement rate. This can be beneficial if you expect your tax rate to be higher in retirement, as your withdrawals will be tax-free once you retire.

Another key difference is related to withdrawals. If you’re concerned about when you’ll be able to take money out of your individual retirement account, there are rules for required minimum distributions (RMD) that Roth IRAs are not subject to. This can make a Roth IRA more appealing for those who do not want to be required to take distributions before they are ready.

However, not everyone is able to fund a Roth IRA. Depending on your income, a traditional IRA may be more suitable.

5 Key Differences Between Roth and Traditional IRAs:

1. Tax Treatment of Contributions

  • Roth IRA: Contributions are made with after-tax dollars and are not tax-deductible.
  • Traditional IRA: Contributions are often tax-deductible, reducing your taxable income for the year.

2. Tax Treatment of Withdrawals

  • Roth IRA: Withdrawals are tax-free if you meet certain conditions (age 59½ and account held for at least five years).
  • Traditional IRA: Withdrawals are taxed as ordinary income in retirement.

3. Required Minimum Distributions (RMDs)

  • Roth IRA: No RMDs required during the account holder’s lifetime.
  • Traditional IRA: RMDs are required starting at age 73.

4. Income Limits for Contributions

  • Roth IRA: Income limits apply. For 2024, single filers with a modified adjusted gross income (MAGI) of $146,000 or more cannot contribute. For married couples filing jointly, the limit is $230,000.
  • Traditional IRA: No income limits for making contributions, but tax deductibility of contributions may be phased out based on income and participation in a workplace retirement plan.

5. Future Tax Considerations

  • Roth IRA: Beneficial if you expect to be in a higher tax bracket in retirement.
  • Traditional IRA: Beneficial if you expect to be in a lower tax bracket in retirement.

Choosing between a Roth IRA and a Traditional IRA involves considering your current and future tax situations, your retirement goals, and your income. Both types of IRAs offer valuable tax advantages, but the right choice depends on your individual circumstances and financial plan.

If you’re unsure which is best for you, consulting with a financial advisor can provide personalized guidance tailored to your needs.

Roth IRA vs Traditional IRA: Considerations Based on Your Stage in Life

Deciding between a Roth IRA and a Traditional IRA can feel like choosing between a round of golf or a day fishing — both have their perks, and the best choice often depends on where you are in your career and your overall retirement savings strategy. Let’s explore how to make this decision based on your life stage and financial situation.

Early Career: The Power of Roth IRA

If you’re early in your career, you might be in a lower tax bracket than you expect to be later in life. This is like starting with a few practice swings before the real game. Contributing to a Roth IRA means you pay taxes on your contributions now, at a lower rate, and reap the benefits of tax-free growth and withdrawals when you’re likely in a higher tax bracket.

  • Example: If you’re just starting out and earning a modest income, a Roth IRA can be a smart choice. For instance, let’s say you’re 25 years old and earning $45,000 a year. By contributing $6,000 annually to a Roth IRA, you pay taxes on that amount at your current tax rate. Over time, your investments grow tax-free, and when you retire, you can withdraw the money without paying any taxes, which can be a huge advantage if you’re in a higher tax bracket then.

Mid-Career: Weighing Both Options

As you progress in your career and your income increases, the decision between Roth and Traditional IRAs becomes a bit more nuanced.

  • Higher Tax Bracket Now: If you’re in a higher tax bracket now and expect to be in a lower one in retirement, contributing to a Traditional IRA might make more sense. You’ll get the immediate tax break, which can be substantial.
  • Maintaining Income Level: If you expect to maintain or increase your income level, sticking with the Roth IRA could still be beneficial for the tax-free withdrawals later on.

Nearing Retirement: Traditional IRA Advantages

For those nearing retirement, a Traditional IRA can offer significant tax advantages, especially if you expect your income (and tax rate) to drop in retirement.

  • Deferring Taxes: By deferring taxes until you withdraw funds in retirement, you might pay a lower tax rate on that income. This can be particularly advantageous if your retirement income sources place you in a lower tax bracket than during your peak earning years.

Blending Strategies: A Balanced Approach

Sometimes, the best approach is a blend of both. Diversifying your retirement savings with both Roth and Traditional IRAs can provide flexibility and tax advantages now and in the future. This balanced strategy can help you manage your tax liabilities and optimize your retirement income.

  • Flexibility and Tax Management: Having both types of IRAs allows you to withdraw from the most tax-efficient account based on your needs and the tax environment at the time.

Weighing Your Options

While Roth IRAs and traditional IRAs share similarities, such as being a way to save and invest your money, one of the key differences between the two retirement vehicles surrounds eligibility. Unlike a Roth IRA, your ability to deduct contributions from your traditional IRA depends on detailed requirements that are important to explore and consider before making your decision.

As long as you don’t contribute to a retirement plan offered by your employer (or even if you do, but your annual salary is less than $74,000), your traditional IRA is fully tax-deductible, while contributions to Roth IRAs aren’t. However, because you make contributions before paying any taxes, your distributions are treated as income, and could, therefore, lead to higher income taxes later on.

For people who are eager to withdraw their contributions, it’s important to note that you may be subject to a penalty if you withdraw any money before you are 59½. Because you’re required to withdraw these funds the year after you’re 72 (if you have not already reached age 70½ by the end of 2024), you will need to steadily reduce your balance and list the distribution amount as part of your income during tax filing season.

This could be a deal-breaker for those who would like to contribute to their savings plan with no limits or restrictions, especially since Roth IRAs do not have an age limit.

Education is Key

When it comes to choosing between a Roth IRA and a traditional IRA, there is no right answer. Everyone is going to have a different preference depending on when they want to pay their taxes, withdraw their distributions and more.

However, it’s important to compare the pros and cons of each before making a decision if you want to make the optimal choice for you and your family.

Preparing for your retirement may seem like a daunting task, but deciding which retirement plan suits your needs the best is the first step to securing your assets, future and well-being for the coming years. Whichever decision you make, it’s important to understand that your individual needs may change, so be sure to not only think about your current preference but also what you might prefer in the years to come.

If you’d like to discuss which the differences in a Roth IRA vs Traditional IRA based on your individual situation, schedule a 15-minute complimentary financial assessment with our team of advisors.

This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties.

Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.


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