Editorial Note: The content of this article is based on the author’s opinions and recommendations alone. It has not been previewed, commissioned or otherwise endorsed by any of our network partners.
If you’re considering putting money into an IRA, you might be wondering which type is right for you: Roth or traditional?
Although both Roth and traditional IRAs are investment accounts geared toward retirement and carry the same contribution limits ($6,000 for 2019), that’s pretty much the end of their similarities. Which type of IRA is right for you will depend on your current earnings, retirement needs and overall personal financial strategy.
Let’s dive into the differences between a Traditional IRA vs. a Roth.
Traditional IRA vs. Roth IRA
|Traditional IRA||Roth IRA|
|Annual contribution limit (2019)||$6,000, or $7,000 for those aged 50 or over||$6,000, or $7,000 for those aged 50 or over (except where limited based on your filing status and income)|
|Income limits (2019)||None||Up to $137,000 for those filing singly or $203,000 for those married filing jointly|
|Tax treatment||Tax-deferred||Taxable in the year of contribution|
|Withdrawal rules||Distributions cannot be taken until age 59 and a half without paying an additional 10% early withdrawal penalty. May be able to withdraw funds penalty-free for certain circumstances, including a first-time home purchase, disability or other factors.||Tax-free distributions cannot be taken until the account has been open for five years and:
|Required minimum distributions||Yes, starting at age 70 and a half||None|
Key differences between traditional and Roth IRAs
As you can see outlined in the chart above, there are some significant differences between traditional and Roth IRAs. Depending on your circumstances, one may offer more benefits for you over the other.
Here are some key points to keep in mind:
Just about everyone is eligible to open a traditional IRA — you need to be under the age of 70 and a half and have earned taxable income. However, when it comes to a Roth, you may not be eligible to participate. If you make $137,000 or more as a single filer — or $203,000 if you’re married and filing jointly — you aren’t eligible to make Roth IRA contributions, and your contribution limits may be reduced if you earn close to that income limit.
There is, however, a “backdoor” Roth IRA option, which can allow high-earners to take advantage of the unique benefits of a Roth account.
The primary difference between a traditional IRA and Roth IRA is not if you will pay taxes, but when. Traditional IRA contributions are tax-deductible today, which means you’ll pay income taxes later when you make withdrawals. But a Roth works differently; you’ll pay taxes on your contributions today, allowing the money to grow tax-free (and you won’t pay income taxes on qualified distributions).
Although the tax break today sounds nice, tax-free income in retirement is also appealing. If you’re planning on being at a higher tax bracket in your golden years than you are now, the Roth might cut a substantial amount off of your total tax burden.
If, however, you’re planning on scaling back and living at a lower income level in retirement, a traditional IRA might make more sense.
You shouldn’t take Roth and traditional IRA distributions before you reach the age of 59 and a half. Fail to wait until you’ve reached that age limit and you’ll pay an additional 10% penalty tax.
If, however, you find yourself in a position where you need to tap into your retirement savings, your IRA may allow for penalty-free early withdrawals. For instance, qualified first-time homebuyers can take out up to $10,000 in early distributions without being penalized, as can those who become disabled.
However, the special circumstances for Roth accounts are governed by the 5-year rule, which stipulates that the account must have been open for five taxable years before you withdraw your account earnings. You can always withdraw your original Roth contributions (sans any capital gains earned) without incurring a penalty because you’ve already paid taxes on them.
Required minimum distributions
Most retirement accounts require you to start making distributions once you reach the age of 70 and a half. These are called required minimum distributions, or RMDs.
But Roth IRAs don’t have them, which means your money can grow indefinitely, even after your death. This is part of the appeal to these types of accounts because they are often passed on to heirs and other beneficiaries.
Which is right for you?
Let’s consider a few examples where a traditional or Roth IRA makes the most sense to you, the saver.
Let’s say you’re a young singleton just starting your career. You earn $35,000, putting you in the 12% tax bracket.
In this case, it might make the most sense to open a Roth IRA. Yes, you’ll have to pay taxes on your contributions, but your current tax burden is already relatively low. Later on when you’ve had time to climb the career ladder — and are earning more and fall into a higher tax bracket — you’ll get a nice break when you start taking distributions. You might also be able to tap into your Roth when you’re ready to buy your first house.
If, on the other hand, you’re married and filing jointly — each earning about $200,000 a year — you might fare better with a traditional IRA. (Good thing, too, since you wouldn’t be eligible to open a Roth in the first place.) You’ll get a tax break today, which may be welcomed considering your income puts you in the 32% tax bracket.
Of course, many of us fall between these two extremes. In that case, the most pertinent question to consider is when you want to pay taxes. If you’re not sure what your earnings will look like in the future, you could always split the difference and contribute to both types of accounts.
It’s all about timing your taxes
Traditional IRAs get you a tax break today, but are taxed when you take distributions. Contributions to Roth IRAs are taxed today, but money grows (and is later withdrawn) tax-free.
Roth IRAs offer certain flexibilities and benefits traditional accounts don’t, but they carry stricter eligibility requirements, and may prevent high-income earners from participating at all.