Traditional IRA vs. Roth IRA
Which IRA you choose depends on when you want to be taxed
Investing in an individual retirement account (IRA) is one of the best ways to save for retirement. But when it comes to choosing your IRA, the most important part is the tax savings.
Both traditional and Roth IRA accounts allow you to save on income taxes, but in very different ways. While a traditional IRA helps you save on taxes now, a Roth IRA helps you save on taxes in retirement.
Key insights
- Both traditional IRA and Roth IRA accounts offer tax advantages.
- Traditional IRA accounts may lower your income taxes in the year you contribute, while Roth IRAs offer tax-free withdrawals in retirement.
- Roth IRAs have income limits to contribute, so some high-income earners may not be eligible.
- If you have a workplace retirement account, your traditional IRA contributions may not be tax deductible.
- Choosing between a traditional IRA and Roth IRA comes down to your current and future tax rate.
How does an IRA work?
IRAs are regulated retirement accounts that allow you to invest for retirement while saving on taxes. You can open an IRA through most major online brokers, and IRAs are not attached to your job (like 401(k) accounts are).
For 2023, you can contribute up to $6,500 into an IRA for yourself, and $6,500 for your spouse as well. The IRS has increased the contribution limits for individuals to $7,000 per year starting in 2024.
You must have earned income to contribute to an IRA, up to the amount of your contribution. So, if your earned income is only $5,000 for the year, you can only contribute up to $5,000 to your IRA account.
The investments inside your IRA grow tax-free until retirement, making it a great way to grow your wealth without paying taxes on the dividends and capital gains within your account. Withdrawals are available without penalty starting at age 59½, but if you withdraw funds early, there may be a 10% penalty.
There are two types of IRA accounts available: traditional and Roth. These two accounts are taxed differently and have different benefits and limitations.
What is a traditional IRA?
A traditional IRA is a pre-tax retirement account, and the contributions reduce your taxable income for the year. This can lower your federal and state income taxes.
Your investments grow tax-free in your traditional IRA until you start to withdraw from the account. Once you begin withdrawals, traditional IRA distributions are taxed at your income tax rate.
Note that if you are covered by a workplace retirement account (401(k) or similar), there are limits on your deductible traditional IRA contributions. If you are filing single or head of household on your tax return, you can earn up to $73,000 and get a full IRA deduction. If you are married filing jointly or a qualifying widow(er), then you can earn up to $116,000 and get a full IRA deduction. Limits are subject to change year to year.
What is a Roth IRA?
A Roth IRA is a post-tax retirement account. Contributions are made on an after-tax basis, meaning you don’t get a deduction in the year you make them.
Your investments grow tax-free in your Roth IRA and withdrawals are tax-free in retirement, meaning you don’t have to count Roth IRA distributions as income.
Since Roth IRA contributions are post-tax, you can access your principal investment at any time without penalty or taxes. This means if you contribute $6,500, you can access that $6,500 at any time. Growth in your Roth IRA account is accessible after age 59½, or under specific circumstances.
Key differences between a traditional and Roth IRA
“The main difference between a traditional IRA versus a Roth IRA is how it is taxed,” said Michael Mezheritskiy, president of Milestone Asset Management Group.
“When you’re putting money into a traditional IRA, you are typically deferring taxes until later and usually are able to take a deduction on your taxes. With a Roth IRA, you first pay taxes, then you contribute to a Roth [without a deduction]. But the biggest benefit of the Roth is that it is growing tax-free forever, so regardless of what happens with taxes (whether they go up or not), you never have to pay income taxes on the gains.”
Here are a few of the key differences between traditional and Roth IRA accounts:
| Traditional IRA | Roth IRA | |
|---|---|---|
| 2023 income limits | No income limits for contributionsTax-deductible contributions may be limited by income and employer retirement plan access | Single filers up to $138kMarried filing joint up to $218k |
| 2024 income limits | No income limits for contributionsTax-deductible contributions may be limited by income and employer retirement plan access | Single filers up to $146kMarried filing joint up to $240k |
| Tax advantages | Income tax deduction in year contributions are madeGrowth and earnings are tax-freeTaxed at ordinary income rates upon withdrawal in retirementEligible for Saver's Tax Credit | No income tax deduction in year contributedGrowth and earnings are tax-freeNo income taxes upon withdrawal in retirementEligible for Saver's Tax Credit |
| Withdrawals | Withdrawals available without penalty starting at age 59½ | Contributions can be withdrawn at any timeWithdrawals after age 59½ (assuming account open at least 5 years) are income tax-free |
| Required minimum distributions (RMDs) | Must begin RMD withdrawals at age 73 if born between 1951 and 1959, or age 75 if born 1960 or later | No RMDs assessed to account ownerRMDs required for account beneficiaries if inherited |
Which IRA is right for you?
When choosing between a traditional or Roth IRA account, it’s important to review your current goals, tax situation, income and retirement plans. Here are a few things to consider before opening a traditional or Roth IRA:
- Income: If you have a high income, you may not qualify for a Roth IRA at all. Single filers making up to $138,000 and married joint filers making up to $218,000 aren’t allowed to open a Roth IRA. If you have a work retirement plan and make too much, your traditional IRA contributions may not be deductible.
- Tax bracket: If you are in a higher income tax bracket and don’t have many deduction options, choosing a traditional IRA may make sense. And if you expect to be in a lower tax bracket in the future, it makes sense to save on taxes now with a traditional IRA. But if you anticipate higher taxes in the future, a Roth IRA could be a better choice.
- Flexibility: Roth IRA accounts let you access your contributions at any time, making them much more flexible.
- Retirement goals: Both traditional and Roth IRA accounts are designed for retirement. It's important to assess your overall retirement strategy, including your tax strategies, before choosing an account.
» MORE: What is a good investment?
How to open an IRA
Opening an IRA is pretty simple. Most major online brokers allow you to quickly open an IRA account online. You will need to submit personal and financial information (similar to opening a bank account), and choose either a traditional or Roth IRA.
Once your account is opened, you can transfer funds over (up to the annual contribution limit). After the transfer is complete, it’s important to invest those funds, as most bank transfers end up in a simple money market account with your broker. Choose your investments and purchase them through your broker.
Once the account is established, most brokers allow you to make automatic contributions on a regular schedule. This helps you dollar-cost average into your retirement account, and regular monthly contributions can help you max out your IRA contributions each year.
FAQ
Can you have both a traditional IRA and a Roth IRA?
Yes, you can have both a traditional and Roth IRA account. But — and this is important — the total contribution limit between the two accounts is currently $6,500 ($7,000 starting in 2024). This means if you contribute $5,000 to a Roth IRA, you can only contribute $1,500 to your traditional IRA.
Is an IRA the same as a 401(k)?
No, an IRA is an individual retirement account that is not tied to your employer, while a 401(k) account is an employer-sponsored retirement account that is tied to your place of employment. While IRAs are set up and owned by you, 401(k) accounts are through your employer, and contributions come straight from your paycheck. A 401(k) may also have matching contributions from your employer, while IRA contributions only come from you.
Are IRAs FDIC-insured?
The Federal Deposit Insurance Corporation (FDIC) covers deposit accounts for banking customers, insuring up to $250,000 per depositor in the case of a bank failure. IRA accounts by themselves are not typically insured by the FDIC, but if you hold money inside your IRA within a deposit account (such as a certificate of deposit or money market account), then the funds may be FDIC-insured. But investments in mutual funds, stocks, bonds or other securities are not covered by FDIC insurance.
Bottom line
Whether you choose a traditional or Roth IRA, investing for retirement is always a good idea. Both accounts offer great tax advantages, but while the Roth IRA offers more flexibility, traditional IRA accounts are great for investors in a high tax bracket.
It’s important to understand the nuances of each account to make sure you’re maximizing your investments — meeting with a licensed financial advisor or CPA tax professional can help.
Article sources
- IRS, "2022 Publication 590-A." Accessed Nov. 10, 2023.
- IRS, "Topic No. 451, Individual Retirement Arrangements (IRAs)." Accessed Nov. 10, 2023.
- IRS, "IRA FAQs - Distributions (Withdrawals)." Accessed Nov. 10, 2023.
- IRS, "Retirement Topics - Exceptions to Tax on Early Distributions." Accessed Nov. 10, 2023.
