Roth IRA vs. Traditional IRA: A Guide To Help You Choose

You’re ready to kick your retirement savings into gear by opening an individual retirement account (IRA) to fund your future lifestyle. But there’s a catch: You don’t know which type of IRA you should open.

But now you can stress less — MagnifyMoney’s here to help you find the best IRA between the two most popular types (Roth IRA vs. traditional IRA). We’ll match them up, then review when each IRA type might be your best option today.

Roth vs. traditional IRA: the comparison

Both Roth IRAs and traditional IRAs are tax-advantaged accounts to help you save for retirement. While both IRAs can offer tax benefits, they vary in meaningful ways that can make one a better fit than the other.

***Early withdrawal penalties: Both Roth and traditional IRAs have exceptions to early withdrawal penalties. The IRS offers a handy chart outlining the exceptions to tax and early withdrawal penalties for IRAs.

Now that you know how these two IRA types stack up side by side, let’s explore each IRA feature in more detail.

Roth IRA vs. traditional IRA contribution limits

Each year, the IRS sets the annual contribution limit for IRAs. Since the contribution limits for both IRA types are the same, there’s no individual IRA that would give you a savings advantage.

But here’s what you’ll need to remember: Annual contribution limits for IRAs are cumulative. Say you’re eligible for a Roth IRA at the beginning of the year and contribute $2,000. Then later in the year, you get a raise that makes you no longer eligible for a Roth IRA. If you open a traditional IRA, you can only contribute an additional $4,000 to that account for the year if the annual limit for your age is $6,000.

Roth vs. traditional IRA income limits

Here’s where the Roth IRA vs. traditional IRA match-up starts to diverge: Each IRA type has different income rules.

Roth IRA income limits

For married filing jointly or qualifying widow(er) contributors:

• You can contribute up to the annual limit if your modified adjusted gross income (MAGI) is below $204,000.
• You can contribute a reduced amount if your income is equal to or above $204,000, but less than $214,000.
• You can’t contribute at all if your income is equal to or greater than $214,000.

For married filing separately (who didn’t live with your spouse during the year), head-of-household or single contributors:

• You can contribute up to the annual limit if your modified adjusted gross income (MAGI) is below $129,000.
• You can contribute a reduced amount if your income is equal to or above $129,000, but less than $144,000.
• You can’t contribute at all if your income is equal to or greater than $144,000.

Since Roth IRA contributions are made after-tax, you can’t deduct contributions on your income taxes.

Traditional IRA income limits

Traditional IRAs don’t have any income limits. If you’re 18 or older, you can open a traditional IRA and contribute up to the annual limit for your age.

Depending on your tax circumstances, you may be eligible to deduct your traditional IRA contributions on your income taxes. The two deciding factors are contributing to an employer-sponsored retirement plan and your annual MAGI. Explore our primer on nondeductible IRA contributions and rules governing tax deductibility.

Roth vs. traditional IRA withdrawal rules

Roth and traditional IRAs also diverge on withdrawals, penalties and required minimum distributions (RMDs).

One caveat to the withdrawal rules for IRAs is that the pandemic changed things up a bit. In March 2020, Congress passed the CARES Act, which lets you take penalty-free withdrawals from your IRAs if you meet specific criteria relating to COVID-19 and dollar amounts. For detailed information about how this legislation might impact your IRA withdrawals, visit the IRS’s CARES Act resource page.

Case study: Roth IRA vs. traditional IRA

Say you’re just 24 years old and just starting your career with a $35,000 annual salary. Over the next 30-something years, you plan on moving up the career ladder and increasing your salary — but for now you’re in the 12% tax bracket, making your annual tax bill roughly $4,200.

Should you open a Roth IRA or a traditional IRA to start?

With a traditional IRA…
You could contribute $6,000 and reduce your taxable income to $29,000. You’ll still be in the same tax bracket but save $720 in taxes. That’ll be a nice refund from the IRS come tax time, right?

But with a Roth IRA…
You’d go ahead and pay that $720 in taxes now and invest the $6,000 in your Roth IRA. Let’s figure you earn a conservative 5% annual return over the next 35 ½ years. If you retire at age 59 ½, that single $6,000 contribution will have grown to $33,913 — which you’d get to withdraw tax-free.

If you’re in a modest 25% tax bracket when you retire, you’d have to pay $8,478 in taxes on that same $33,913 with the traditional IRA.

In this situation, the Roth IRA is the better choice. You’ll pay $720 in taxes today but avoid an $8,478 tax bill in the future. No matter how you do that math, that’s a substantial saving and boost to your retirement cash flow.

4 potential reasons to choose a Roth IRA today

To help you explore which IRA type might be right for you, these situations cover when a Roth IRA might make better sense:

1. You meet the income limits. Even if your income increases down the road, you can start your retirement savings with a Roth IRA, enjoy tax-free withdrawal on a portion of your retirement income and later switch to a traditional IRA if your income increases beyond the allowable limit.
2. You anticipate a higher retirement tax bracket. If you expect your income to rise and later disqualify you from Roth IRA contributions, take advantage of them when a lower income means a lower tax bracket.
3. Potential to avoid penalties. Roth IRA contributions are made after-tax and can be withdrawn without penalty at any time. If necessary, you can tap your Roth contributions without penalty to address an emergency, avoiding early withdrawal penalties from a traditional IRA or 401(k).
4. You want to avoid RMDs. RMDs can increase your retirement income and thereby increase your Medicare premiums. Without RMDs, you’ll have better control over both your taxes and expenses in retirement.

4 potential reasons to choose a traditional IRA today

Sometimes, a traditional IRA will make more sense for you. You might opt for a traditional IRA over a Roth IRA if:

1. You don’t meet the Roth IRA income limits. If you don’t qualify for an IRA, you should still take advantage of a traditional IRA to build your retirement nest egg.
2. You anticipate a lower retirement tax bracket. Today’s high earners might be better off with a traditional IRA — especially if you qualify to deduct your contributions and expect a much lower income (and lower tax bracket) when you retire.
3. You need the tax deduction. Even if you’re not a high earner, a traditional IRA could be a better choice if you need more cash in your pocket. You can deduct the contributions on your taxes, which will decrease your tax bill — and maybe even score you a bigger refund.
4. You want to qualify for tax credits. Beyond paying less in income tax, your traditional IRA contributions could help you qualify for certain tax breaks, like the Child and Dependent Care Credit or the Retirement Savings Contributions Credit. Since traditional IRA contributions are potentially tax-deductible, they can reduce your MAGI — a critical qualifying factor for many tax credits.

The bottom line

When you compare a Roth IRA vs. a traditional IRA, your decision today will likely come down to two things: annual income and tax benefits. Our best advice is to run the numbers, as they don’t lie. You’ll see which IRA type is the best decision for where you are today. And remember — you can always open a different type of IRA down the line if your income and tax needs change.