Traditional IRA vs. Roth IRA: What’s the Difference?

It's all about when you want to pay taxes

Couple talking to an advisor about Roth and traditional IRAs
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Individual retirement arrangements (IRAs) are savings accounts. They have tax and growth advantages over other types of accounts. There are two types you can choose from: a traditional IRA or a Roth IRA. The main differences between the two are when you pay taxes and when you need to begin withdrawing from them.

Learn more about the differences between Roth and traditional IRAs.

What's the Difference Between a Roth IRA and a Traditional IRA?

Traditional IRA Roth IRA
Tax Benefits Tax-deductible contributions and tax-deferred growth Tax-free growth potential; qualified withdrawals are tax-free; non-deductible contributions
Income Requirements No income limitation Has income limitations
Required Minimum Distributions Must take required minimum distributions No required minimum distributions
Early Withdrawals Full amount penalized Only earnings are penalized

Tax Benefits

Contributions to a traditional IRA may be tax-deductible at the time they are made. But income taxes must be paid when you withdraw funds in retirement. For that reason, high-earners may prefer a traditional IRA over a Roth IRA. That's because they reap the tax savings upfront; they'll take the tax hit in retirement. At that point, they may be in a lower income tax bracket.

Anyone over age 18 may contribute to an IRA, but high-earners should be aware that tax deductions for contributions to a traditional IRA may be limited. In some circumstances, they may not be allowed. If you or your spouse have a retirement plan at work, and your modified adjusted gross income (AGI) exceeds a certain limit, you might not be eligible.

Contributions to a Roth IRA are made with after-tax dollars. A key benefit of a Roth IRA is that qualified distributions are tax-free. That means any growth of the funds in a Roth IRA will not be taxed, which is why they are such a great investment option for those who start saving early.

Note

Contributions to a Roth IRA are not tax-deductible. That's because withdrawals are not taxed.

For the tax year 2021, no deduction is allowed if you file as single or head of household with an AGI of $76,000 or more. And if you're married filing jointly, you cannot take a deduction if you have an AGI of $125,000 or more. The same is true if you're a qualifying widow(er).

If you or your spouse don't have a plan at work, you're able to fully deduct your contributions. This is true as long as you make less than $208,000 combined or partially if your combined incomes are between $198,000 and $208,000.

Income Requirements

As the chart above explains, Roth IRAs have an income cap. If you exceed it, you may be limited on how much you can contribute to a Roth IRA, or you may not be able to contribute at all.

For the tax year 2021, if you're a single taxpayer with a modified AGIG of $140,000 or more, you cannot contribute to a Roth IRA. But if you earn between $125,000 and $140,000, you can make partial contributions.

Important

Traditional IRAs do not have income caps. They only have only contribution limits.

The income limit is $208,000 for married taxpayers who file jointly. If you earn between $198,000 and $208,000, you can make partial contributions.

Distribution Rules

One of the big differences between a traditional IRA and a Roth IRA is that you're not required to withdraw funds from a Roth IRA. That's because you have already paid taxes on the funds. Since taxes on a traditional IRA are deferred, the government requires withdrawals so that you will pay taxes.

Early Withdrawals

If you have a traditional IRA, you must begin withdrawing funds once you turn 70 1/2 or 72, depending upon your date and year of birth. This single difference makes many people select the Roth over a traditional IRA.

Withdrawals from a traditional IRA before age 59 1/2 typically trigger a 10% early-withdrawal penalty. But there are exceptions and life events that allow for early withdrawal. These include permanent and total disability, qualified education expenses, and the qualified first-time purchase of a home.

Similarly, there is a 10% early-withdrawal penalty for withdrawing earnings from a Roth IRA before age 59 1/2. But contributions to a Roth IRA are post-tax. That means there are no restrictions or penalties for withdrawing your original contributions before age 59 1/2. Of course, it’s always wise to keep retirement savings invested and growing. But this feature provides flexibility. It can be helpful if unexpected financial situations arise.

Important

The CARES Act waived RMDs for 2020; RMDs are required for 2021, before December 31.

Other IRA Considerations

There are many other factors to think about when you're comparing Roth and traditional IRAs. Some of those factors are:

  • Whom will you open the account with?
  • Will you have more than one account?
  • How much can you contribute?
  • What if you change your mind about the type of IRA?

Opening an IRA

Many of the same institutions where you handle other aspects of your financial life can help you set up an IRA. Some are brick-and-mortar businesses, like banks and credit unions. There are also online options and firms, like Charles Schwab, Fidelity, or E-Trade.

Each broker will have different options for you to choose from and different investment types within each of their packages. Ensure that you know what asset types the IRA you're looking at is composed of; for instance, stocks, bonds, other funds. Be sure you're comfortable with the risks of investing in the IRA you choose.

Tip

Take the time to understand all of the IRA investment options offered before you decide which firm to go with.

Multiple Retirement Accounts

It is possible to have multiple IRAs in addition to having a work-sponsored retirement plan. For instance, many people have what is known as a "rollover IRA." That is what they use when they leave a job and wish to move their 401(k) balance from that job into a different account. There are important rules for shifting funds in that sort of situation to avoid penalties.

Contribution Limits

There is a maximum amount you can contribute to all of your IRAs. It doesn't matter whether that money is put in a single IRA or spread over multiple IRAs. For 2021, the limit is $6,000. But if you're 50 or older, you can contribute $7,000 as part of a “catch-up” policy.

Converting a Traditional IRA to a Roth IRA

What if your situation changes mid-career? What if you change your mind about the type of IRA you need? You can always convert a traditional IRA into a Roth IRA. That can be a good idea when your tax bracket changes; or, it can be helpful if you decide you'd rather have the tax-free withdrawals of a Roth IRA. Just be aware that a conversion will trigger a tax on any of the untaxed amounts in the traditional IRA.

Which IRA Is Right for You?

Deciding which IRA you should have depends on your earnings and tax situation when you begin contributing; it also depends on your financial circumstances when you expect to begin your withdrawals.

Retirement accounts are built around tax incentives. Traditional IRAs offer qualified participants tax breaks upfront. Taxes are only incurred upon withdrawing the funds. Roth IRAs do the opposite. That's because they are funded with post-tax dollars. There are no taxes on withdrawals in retirement.

Important

If you expect to be in a lower tax bracket in retirement than you are now, then a traditional IRA may be right for you. But what if you'll be in a higher bracket? In that case, it might be worth it to look into a Roth IRA.

Apart from taxes, if you want to begin your withdrawals early, Roth IRAs don't have early-withdrawal penalties on original contributions like traditional IRAs. So if you leave the earnings untouched until age 59 1/2, you can make withdrawals on your principal.

The Bottom Line

The tax benefits and required minimum distributions are the keys to deciding which one of the two retirement accounts is better for you. Work through your finances to see where you are now and where you'll be when you want to retire. That can help you decide which is better for you.

If you still can't decide, discuss your plans with a financial advisor. They can help you weigh the features and benefits of both types of accounts. They can also help you forecast a realistic financial future.

Key Takeaways

  • A traditional IRA provides tax incentives on the front end through tax-deductible deposits. A Roth IRA allows after-tax dollars to grow tax-free; qualified withdrawals are not taxed.
  • Income caps may prevent high earners from contributing to a Roth IRA.
  • For the tax year 2021, the annual contribution limit for both a traditional IRA and a Roth is $6,000. It's $7,000 for those who are age 50 or older.
  • It helps to forecast the tax bracket you'll be in when you want to retire. That way, you can decide which IRA is better for your current and future circumstances.