Roth IRA vs Traditional IRA: How to Choose

Retiring calls for a well-structured retirement plan and an individual retirement account (IRA) that will help you secure funds for your golden years.

A Roth individual retirement account and a traditional account are two popular IRA choices for investors who plan to build a financially secure future.

Both options offer retirees different tax advantages, including a potential tax break.

This guide compares a traditional IRA and a Roth IRA to see their benefits, tax savings, limitations, and which would best fit your goals.

Understanding Individual Retirement Accounts

Before delving deeper, it is important to gain some insights on individual retirement accounts since this can affect your decision on whether to get a Roth IRA vs a traditional IRA.

Let’s begin with a brief definition. An IRA is a special savings account that allows a retiree to save money for retirement while being provided with tax advantages such as tax breaks.

IRAs are useful for people who do not have a company retirement plan, such as a 401(k).

Setting one up allows your tax savings and investments to grow without having to pay taxes or with taxes deferred until years later.

Defining Roth IRA

Roth IRA contributions use after-tax dollars, meaning each contribution is already taxed. This means that withdrawing money will not incur additional taxes.

However, note that contributions to a Roth IRA cannot be claimed as a tax-deductible.

Additionally, there are no required minimum distributions (RMDs) for Roth IRAs, making your savings eligible for tax-free growth.

Defining Traditional IRA

Traditional IRA contributions are tax-deductible. Your investments and deposits, whether they are contributions or earned income, grow tax-deferred.

This means your taxes are not paid on any earnings until you withdraw money during retirement. Note that traditional IRAs don’t offer the same tax benefits as a Roth IRA.

Unlike Roth IRAs, traditional retirement accounts have required minimum distributions (RMDs) that account holders need to begin withdrawing by age 73.

Investors need to withdraw money based on the minimum annual contribution limit set by the Internal Revenue Service (IRS) rules.

The Role of IRAs in Retirement Planning

Aside from providing a source of income, having an individual retirement account (IRA) is great to have for a retirement plan. The reasons include the following.

• Lets an investor’s retirement savings grow with little intervention.
• Investment opportunities and flexibility from stocks, mutual funds, and more.
• Financial stability and wealth via estate planning.
• Retirement independence if you don’t have an employer-sponsored retirement plan.

Distinguishing Features of Roth IRA and Traditional IRA

After learning the differences between a Roth IRA vs traditional IRA, let’s compare their specific features like required tax considerations, income limits, and regulations.

Tax Considerations

Crafting a retirement plan involves looking at many factors.

One of these is tax considerations, which can help you manage financial expectations in your retirement plan and maximize your finances during this period.

Pre-tax and Post-tax Contributions

As mentioned previously, since Roth IRA investments are made with after-tax money, Roth IRAs do not involve pre-tax contributions, which also makes withdrawals tax-free.

However, these tax advantages cannot be enjoyed upfront and will be available during the retirement phase.

Traditional IRA contributions are done with pre-tax dollars and are subject to tax-deductibility. These contributions lessen your income for the year they are deposited, which means taxes are deferred until you need to withdraw money during retirement.

Nondeductible contributions made to a traditional IRA are referred to as post-tax. In case the contribution does not reduce your taxable income, you won’t be subjected to income taxes.

It will just reduce your earned income for the year.

Tax Deductions and Non-deductions

A traditional and Roth IRA differ when it comes to deductions.

Because of after-tax dollars, tax deductibility is not applicable to a Roth IRA vs traditional IRA. Traditional IRA contributions are tax-deductible and already offer immediate tax advantages.

Tax-Free and Tax-Deferred Earnings

As mentioned previously, Roth IRA investors can enjoy tax-free growth on any earnings that their investments make. This is because this account functions with after-tax dollars.

Meanwhile, tax-deferred earnings are associated with a traditional IRA since contributions are made with pre-tax dollars, which lets your savings grow tax-deferred.

Income Eligibility

Income eligibility is one of the main features of an IRA as it determines your eligibility in opening an account.

Income Restrictions for Roth IRA

Before you can open a Roth individual retirement account, you’ll need to determine your modified adjusted gross income (MAGI) to check whether it fits within the Roth IRA income limits.

MAGI is determined by identifying your adjusted gross income (AGI) and including certain additional deductions, such as Roth IRA contribution limits, student loan interests, as well as self-employment taxes.

To make contributions, a single tax filer must have a MAGI of less than $153,000 for the tax year 2023. The value will increase to $161,000 this 2024.

For investors who are married filing jointly, they should have a MAGI of less than $228,000 for 2023, and $240,000 for the year 2024.

Income Considerations for Traditional IRA

Income considerations for a traditional individual retirement account, however, have fewer limitations and regulations.

Having taxable compensation is significant in contributing to a traditional IRA, whether the tax filer is single or married filing jointly. These include different forms of income, such as:

• Wages
• Salaries
• Commissions
• Tips
• Bonuses
• Net Income

Compared to a Roth IRA, traditional IRA contributions are not restricted by annual income. This means that any individual who earns an income is eligible for this account.

However, it is worth noting that the contribution will not be fully deductible.

Contribution Rules

Roth and traditional IRAs are both subject to the contribution rules set by the IRS in order to manage the amount of money investors can deposit in a tax year.

There are two things to take note of: the annual contribution limit and age-related contribution rules.

Annual Contribution Limits

The annual contribution limit refers to the maximum amount of money IRA account holders must contribute to their individual retirement account (IRA). This helps maintain tax planning and government revenue management.

The combined contribution limit for IRAs, both Roth and traditional, amounts to:

• $6,500 in 2023 ($7,500 if age 50 or older)
• $7,000 in 2024 ($8,000 if age 50 or older)

Age-Related Contribution Rules

As seen previously, people age 50 or older are expected to pay:

• $7,500 in 2023
• $8,000 in 2024

For people below 50, they are expected to pay:

• $6,500 in 2023
• $7,500 in 2024

However, keep in mind that age is not a hindrance to IRA eligibility. We’d like to reiterate that there is no age limit for opening or contributing to an IRA.

Regulations on Withdrawals

Generally, Roth IRA withdrawals should be taken after a five-year long holding period and after the account holder reaches 59 and a half years of age to avoid penalties.

Traditional IRA withdrawals taken before the account holder reaches the required age will be included in gross income along with a tax penalty.

Early Withdrawal Penalties

Whether you have a traditional IRA or a Roth IRA, withdrawing before 59 and a half years is subject to an early withdrawal penalty that amounts to 10% of the withdrawn retirement savings.

Investors can, however, make penalty-free withdrawals for Roth IRA contributions anytime since they are made with after-tax dollars.

Only the earnings on a Roth IRA are not subject to the early withdrawal penalty.

Required Minimum Distributions

In a nutshell, RMDs are minimum fees that IRA holders have to withdraw annually. These distributions are needed to make sure tax-deferred account holders pay taxes on their deposits.

However, these distributions are only applicable to a traditional account since it uses pre-tax dollars. Since a Roth IRA works with after-tax dollars, they aren’t subject to RMDs.

Evaluating Roth IRA and Traditional IRA: Pros and Cons

Now that we know their features, let’s discuss some of the pros and cons of Roth and traditional IRAs.

Benefits of Roth IRA

One of the biggest reasons to invest in a Roth IRA is the tax benefit it offers. Here are more of the many advantages of choosing Roth IRA compared to a traditional one.

Tax-Free Withdrawals

An advantage of Roth IRAs is having penalty-free and tax-free withdrawals by the time investors reach the age of 59 and 1/2 years.

In order to enjoy this benefit, ensure that you meet the minimum account holding period of 5 years.

No Required Minimum Distributions

There are no RMDs for Roth IRAs. This advantage lets your money grow continuously.

Drawbacks of Roth IRA

Although Roth IRAs have a lot of benefits, there are also some cons to take into consideration.

Income Limitations

Despite having no RMDs, Roth IRAs have income limitations that depend on the tax filers’ status and modified adjusted gross income (MAGI).

The MAGI for a single tax filer should amount to less than $153,000 for the tax year 2023, and $161,000 for 2024.

For a married couple filing jointly, their MAGI should be below $153,000 for 2023 and $161,000 for 2024.

No Immediate Tax Deduction

As mentioned earlier, contributions made to Roth IRAs use after-tax money. While this is one of its known advantages, investors who set up this IRA type will not enjoy a tax deduction while contributing.

This drawback leads to delayed tax benefits and advantages compared to a traditional IRA.

Benefits of Traditional IRA

Moving on to the traditional IRA, below are some key benefits for people looking into opening this account.

Tax Deductible Contributions

Since traditional IRA contributions are tax-deductible, investors get an immediate tax benefit when contributing. With this, your taxable income can be reduced for the year of your contribution, leading to lower income taxes.

As mentioned, traditional IRA contributions are tax-deferred and are made with pre-tax dollars. While your investment funds grow, banks will not deduct contributions from your investments to pay taxes.

No Income Limit for Contributions

Unlike a Roth IRA, a traditional IRA does not have income limits when making contributions.

People who earn income and pay taxes are eligible to contribute to a traditional IRA, given that they meet the required qualifications to do so.

Note that even if your income changes over time, you can still continuously contribute to a traditional account.

Drawbacks of Traditional IRA

Despite its benefits, traditional IRAs also have some drawbacks.

Required Minimum Distributions

While a Roth IRA does not have required RMDs, it is the opposite for a traditional IRA.

By the age of 72, account holders are expected to withdraw a minimum amount of money from their IRA and will be penalized by 25% of the tax bill owed if they fail to do so.

Taxable Withdrawals

Since traditional IRAs use tax-deductible contributions, the income stored in the account grows tax-deferred. Account holders don’t need to start paying taxes until they withdraw earnings.

Any money withdrawn from a traditional IRA will be taxed appropriately.

Eligibility Criteria for Roth IRA and Traditional IRA

Like any big decision, especially one that calls for financial responsibility, Before you can set up an IRA, it is important to know if you meet the criteria to open one first.

Below are some eligibility criteria to consider.

Eligibility Based on Income and Age

As mentioned earlier, your modified adjusted gross income plays a big part in your IRA.

For a Roth IRA, single tax filers must have a MAGI of less than $153,000 for 2023 and less than $161,000 for 2024.

For a married couple, their MAGI should be below $228,000 for 2023, and $240,000 for 2024.

For a traditional IRA, there are no income limits that account holders need to stay within in order to make contributions.

As for age limitations, there are none when making IRA contributions. That means a contributor can begin making contributions to an IRA, no matter how young or old they are.

Note, however, that withdrawals for a Roth IRA need to be made after age 59 and 1/2 and must be taken after a five-year holding period. Otherwise, account holders must pay a tax burden or a 10% early withdrawal penalty.

Deductibility of Contributions

Roth IRA contributions are not tax-deductible since they are made using after-tax dollars. In exchange, investments grow to be tax-free and will not be subject to any liability and tax burden when withdrawn.

Account holders are eligible for contribution deductions for traditional IRAs if their modified adjusted gross income is $73,000 for 2023 and $77,000 for 2024.

Account owners can benefit from a partial deduction if their income is between $73,000 and $83,000 for 2023, and $77,000 and $87,000 for 2024.

If your income is higher than the previously mentioned limits for 2023 and 2024, you cannot get a tax break.

Eligibility for Roth IRA: Special Considerations

One very important consideration to look into when thinking of opening a Roth IRA is how your future income and ordinary income taxes will be compared to your current income tax rate and tax situation.

Potential account holders need to identify whether their tax rate will be in a higher or lower tax bracket since traditional IRA and taxable earnings decrease during retirement.

In case you think your tax bracket will be higher by the time you retire, getting a Roth account might be more helpful to potentially increase your tax advantages in the future.

Dual Contribution: Roth IRA and Traditional IRA

There’s no limit to how many IRAs an investor can hold.

Having two IRAs increases tax and investment diversification. Below are some factors to better understand dual IRA contributions.

Feasibility of Dual Contributions

If you are eligible, it is possible to invest in both a Roth IRA and a traditional IRA as long as the account holder follows the maximum annual contribution limit set by the Internal Revenue Service (IRS).

Workers who are aged 50 or older can also make catch-up contributions.

Employed account holders can further maximize their contributions if they have a Roth IRA alongside an employer-sponsored retirement plan.

Financial Implications of Dual Contributions

Having two IRAs can provide different financial advantages as long as you are willing to manage both accounts. Here are some to know.

1. Tax Diversification
   One of the main reasons an investor might decide to open two different IRAs is to maximize and enjoy the different tax advantages offered by both accounts.
   As mentioned previously, Roth IRAs offer tax advantages during retirement, whereas a traditional account offers a tax break upfront.
2. Investment Diversification and Market Exposure
   Other than pensions, ordinary income tax, and savings, investments play a big part in providing additional financial security for retired investors.
   Contributing to both traditional and Roth IRAs can broaden your investments and manage risks.
3. Estate Planning
   By having two IRAs, account holders can use this for estate planning purposes by adding beneficiaries per account. This can also potentially help your inheritors pay off their tax liabilities in the future.
   Roth IRAs offer tax-free distributions to their heirs, while a traditional IRA provides tax implications.
4. Immediacy of Tax Advantages from Withdrawals
   Traditional and Roth IRAs have separate withdrawal regulations. Like we discussed above, traditional account contributions are tax-deductible and deliver immediate tax assistance. For a Roth IRA, withdrawals remain tax-free.
   Depending on your own goals and tax situations, you can use these advantages to optimize your strategies for financial growth.
5. Backdoor Roth
   In case you do not have the means to set up or contribute to a Roth IRA or if your income is too high, potential investors have the option to utilize their traditional IRA to fund a backdoor Roth IRA.
   However, despite its advantages, it’s vital to follow specific rules in order to avoid paying extra taxes when setting up an IRA this way. Consult a financial advisor to create a backdoor Roth IRA properly.

Navigating Early Withdrawals and Minimum Distributions

Be careful not to create any dents in your savings by making early withdrawals and neglecting to take minimum distributions. This section covers how these two factors can affect your IRA funds.

Rules for Early Withdrawals

Prepare for penalties if you withdraw from your IRA before reaching the age 59 and a half. The account holder shall be subjected to a 10% tax penalty with an additional income tax owed on the distribution.

Keep in mind that this penalty fee applies if you withdraw taxable funds.

To avoid the consequences of early withdrawals, it is advisable to delay withdrawals before reaching the eligible age. There are also some scenarios that waive the penalty.

IRA holders may use the funds for unreimbursed medical expenses that cost more than 7.5% of their adjusted gross income, or use it to pay for qualified higher education expenses.

Understanding Required Minimum Distributions

RMDs are equivalent to the minimum amounts account holders have to withdraw from their IRAs yearly.

These fees are required by the government to produce tax revenue.

Choosing the Right IRA for Retirement Saving

Despite some similarities between a Roth IRA vs traditional IRA, it is important to understand the different tax benefits, withdrawal limits, and contribution rules each has.

Factors Influencing IRA Choice

When deciding which IRA to choose, there are a couple of factors to consider.

Financial Goals and Retirement Plans

Your financial goals and retirement plans should allow investors to shape their investment and tax strategies.

It is also crucial to establish your IRA eligibility. Having well-defined goals and a retirement plan ready is a good step in identifying which IRA potential account holders should get.

We strongly suggest consulting with a trusted financial or tax advisor. Their experience and expertise will help educate and explain the qualifications and requirements investors should meet before deciding on an IRA.

Income Level and Tax Considerations

It’s important to also consider your current and expected income level during retirement, and whether you want an IRA that offers tax savings or not.

Your current income and tax bracket also indicate which IRA you are eligible for.

For those who are in a lower income bracket, keep in mind that traditional IRA contributions deduct taxes and lower your taxable income. However, you’ll need to pay taxes on these contributions when you withdraw them during retirement.

On the other hand, a Roth IRA works by not giving the account holder an immediate tax break. Withdrawals are not subject to taxes and penalties either.

Recommended Roth IRA and Traditional IRA Providers

It is important to work with trusted finance institutions and providers who will provide their clients with the knowledge they need and assist them in every step of the process.

We have rounded up some of the best finance establishments that offer IRAs as part of their expertise.

1. Charles Schwab
   Having been recognized as one of the Most Trusted Financial Companies by Investor’s Business Daily Best of the Online Brokers Survey, it comes as no surprise that Charles Schwab is one of today’s honored financial institutions in America.
   The company offers various financial and investment services, including retirement plans and accounts, brokerage and trading, and more.
   Opening an IRA with them is a smart choice if you want to be taken care of by one of the best names in the finance industry.
2. Wealthfront
   Since its establishment in 2008, Wealthfront continues to be a trusted advisor when it comes to IRA planning. Leave it to them to go over the complexities of setting up an IRA, the do’s and don’ts, and helping you achieve your financial and retirement goals.
   In the Investopedia 2023 Best Robo-Advisor Awards, this American automated investment service company bagged four out of eleven awards, including Best Goal Planning and Best Overall.
3. Vanguard
   Vanguard has a fine reputation in the finance industry. It’s little wonder that investors and IRA owners put their trust in this financial institution, with their long-term commitments and vision for their clients.
   They have been included in NerdWallet’s list of 16 Best Roth IRA Accounts of January 2024, Bankrate’s Best Roth IRA Accounts in 2024, and has been identified as Best IRA for Experienced Investors in CNBC’s list of Best IRA Accounts recently.

Frequently Asked Questions

To learn more about traditional and Roth IRAs, read through these FAQs.

What Are the 2023 Roth IRA Contribution Limits?

The Roth IRA contribution limits you have to keep in mind will differ based on the age of the account holder.

For account holders age 50 or older, the maximum contribution limit combined should be $7,500. For those below 50, the contribution limit is reduced to $6,500.

What Is the Difference Between a Roth IRA and Traditional IRA?

Roth IRAs and traditional IRAs vary from one another based on their tax treatment of contributions and withdrawals.

Roth IRAs differ by using after-tax dollars, which are not tax-deductible. This allows the money to grow penalty-free and tax-free. Qualified withdrawals are also tax-free during retirement.

Traditional IRAs involve tax-deductible contributions, which reduce the taxable income during the year of the account holder’s deposit or contribution.

Compared to Roth IRAs, however, withdrawals are subject to taxes during your retirement period. Account holders must also make RMDs by age 72, or 73 if they turned 72 after Dec. 31, 2022.

What Are the Benefits of a Roth IRA?

When comparing a Roth IRA vs traditional IRA, you’ll find that the former’s tax benefits do not happen immediately. However, a Roth IRA does offer various advantages for a retiree.

Since Roth IRAs have tax-free and penalty-free withdrawals and contributions, this can be beneficial for younger investors who are more likely to have been in a lower tax bracket today than their retirement period.

Other than that, a Roth IRA also has no minimum distribution requirement (RMD), and can be passed on to the account holder’s beneficiaries.

What Is the Income Limit for a Roth IRA?

Roth IRA income limits depend on the following two factors.

1. The account holder’s status, whether they are a single tax filer or married, filing jointly.
2. The account holder’s modified adjusted gross income (MAGI).

For single tax filers, the modified adjusted gross income should be under $153,000 for tax year 2023, and $161,000 for tax year 2024. The maximum contribution per person amounts to $129,000. Those who earn between $119,000 to $144,000 can contribute to the prorated phase.

For a married couple that files jointly, the MAGI should be under $228,000 for tax year 2023 and $240,000 for tax year 2024. A couple can contribute up to $214,000 to the earned income.

Is It a Good Idea to Convert an IRA to a Roth IRA?

When comparing a Roth IRA vs traditional IRA, you will learn that you can convert traditional IRAs to Roth IRAs.

This decision should be based on the individual’s financial goals and their preferred way of adding to their investments, using their tax benefits, and more.

Overall, Roth IRAs provide tax-free income, tax-free growth, and estate planning advantages in the future.

However, an account holder will then be subjected to pay taxes during their contributions, which could cost a higher tax rate compared to what they will owe during retirement period.

Conclusion

Both IRAs offer great advantages and tax breaks.

Getting a Roth IRA is ideal if you want your retirement savings to be as tax-free as possible. This choice is also highly suggested for people who expect to be in a higher tax bracket once they retire.

On the other hand, traditional IRAs are more favored for those who prefer to utilize tax advantages while contributing. This is also ideal for people who expect to move to a lower tax bracket during retirement.

Before choosing either IRA, it’s best to seek the assistance of a trusted financial or tax advisor to help you get things started.

With their help, it will also be easier to grasp certain complexities of owning an IRA, including advantages and opportunities for tax breaks.