Roth vs. Traditional IRA: 4 Key Differences You Should Know

A key part of retirement planning is deciding where you’ll put the money you save. In many cases, your employer may offer some kind of retirement plan (such as a 401k). This can be a great place to stash some of your retirement savings, particularly if your employer will match your contributions.

But what if you want to save more than your employer’s plan permits? What if your employer doesn’t offer a retirement plan? Or what if you’re self-employed? In all of these cases, you should consider an Individual Retirement Account (IRA).

When you set up an IRA, you’ll need to choose between two main types: Roth IRA and Traditional IRA. At first glance, these two types of IRAs seem very similar. However, there are some key differences that can affect how much money you’ll have available to you in retirement.

To help you make the best choice for your situation, we’ve put together this comparison of Roth and Traditional IRAs. Below, you’ll learn the similarities and differences between the two types of retirement accounts (and why they matter to you).

Roth vs. Traditional IRA: 3 Key Similarities

Before we get into the differences between Roth and Traditional IRAs, let’s look at what they have in common:

Tax-Advantaged Savings

Both types of IRAs are designed to help individuals save for retirement.

To incentivize retirement savings, the U.S. government taxes IRAs differently from regular brokerage accounts. How the government taxes the money in your IRA depends on whether you choose a Roth or Traditional IRA (see below).

But because of the tax advantages, both types of accounts are a more desirable place to start saving for retirement than a run-of-the-mill brokerage account.

Contribution Limits

In general, Roth and Traditional IRAs have the same contribution limit. The contribution limit is the maximum amount of money you can put into the account each tax year.

For 2022, you can contribute up to $6,000 to your IRA if you’re under age 50. If you’re over the age of 50 (or will turn 50 by the end of 2022), then you can contribute up to $7,000.

Note, however, that the amount you can contribute to a Roth IRA could be lower than these numbers if your income is very high (we’ll discuss this more in the “Differences” section).

Contribution Deadline

You can contribute to both Roth and Traditional IRAs up until your tax filing deadline. In almost all cases, this is April 15. So, for example, you can put money in your IRA for 2022 until April 15, 2023.

When you make a contribution, your brokerage account will ask you to specify which tax year you want your contributions to count towards.

Want to start investing but aren’t sure how? Check out this beginner’s guide.

Roth vs. Traditional IRA: 4 Key Differences

Now that we’ve covered what Roth and Traditional IRAs have in common, let’s look at the key differences:

Traditional IRA Contributions Are (Usually) Tax-Deductible

With a Traditional IRA, you get to deduct the amount you contribute to the plan when you file your taxes. This deduction can reduce your overall taxable income, thus potentially lowering your final tax bill.

Typically, you can deduct up to the maximum amount you’re allowed to contribute to the IRA. So if you contributed $6,000 for the tax year in question, you can deduct $6,000. However, there are some exceptions to be aware of.

Mainly, you may not be able to deduct the full amount if:

• You or your spouse is covered by a retirement plan at work AND
• Your income exceeds a certain level.

Simply having an employer-sponsored retirement plan won’t automatically disqualify you from deducting your contributions. Consult the links above (or an accountant) for specific guidance on your situation.

Roth IRA Withdrawals Are (Usually) Tax-Free

When you contribute money to a Roth IRA, you don’t get to deduct it on your taxes like you would with a Traditional IRA. But in exchange for giving up the tax deduction, you won’t have to pay taxes on the money you withdraw from your Roth IRA in retirement.

However, it’s a little more complicated than this in practice. To start, you can withdraw any of your Roth IRA contributions at any time without penalties or taxes. Because this money has already been taxed, it’s yours to withdraw whenever you want. (Though we don’t recommend taking any money out of your Roth IRA until you retire).

But what about the money the investments in your Roth IRA earn? You can start withdrawing your Roth IRA earnings tax-free when:

• You’re over the age of 59.5 AND
• You’ve had the Roth IRA account for at least 5 years.

If you withdraw Roth IRA earnings before the above conditions are true, you may have to pay a 10% tax (unless you qualify for an exception).

All of this is in stark contrast to a Traditional IRA. With a Traditional IRA, any money you withdraw is taxable at your current income tax rate. Furthermore, you’ll have to pay an additional 10% tax on contributions and earnings you withdraw before age 59.5. Unless you qualify for an exception, of course.

Roth IRAs Have Income Limits

If your income is above a certain level, you may not be eligible to contribute to a Roth IRA. And if you’re married filing jointly, then you may also be ineligible if you and your spouse’s income is above a certain point.

These income levels are quite high compared to the U.S. median household income, but they’re still something to be aware of. The limit varies based on whether you’re filing single or married filing jointly.

For 2022, you’re ineligible to contribute to a Roth IRA if your modified adjusted gross income (MAGI) is higher than $144,000 and your filing status is single. Furthermore, the amount you can contribute to a Roth IRA is reduced once your MAGI is higher than $129,000.

If you’re married filing jointly, then you’re ineligible to make Roth IRA contributions once your MAGI passes $214,000. And the amount you can contribute is reduced starting at a MAGI of $204,000.

Wondering how much your contribution amount will be reduced? Follow the instructions at the bottom of this IRS page. Or, better yet, consult an account or certified financial planner.

Traditional IRAs Require You to Take Distributions (Eventually)

The final main difference between Roth and Traditional IRAs is when you’re required to start taking distributions (withdrawing money from the account).

If you have a Traditional IRA, you’re required to start taking money out of the account when you reach age 72. The IRS refers to this as a Required Minimum Distribution (RMD).

You can calculate how much you need to withdraw using these IRS worksheets. But since the penalty for not withdrawing enough can be quite high, we recommend talking with an account or certified financial planner to be sure.

In contrast, a Roth IRA has no required minimum distributions. You’ll likely be taking money out of your IRA before you reach age 72 (no matter the type you have). But if you’re interested in passing your IRA along to your children or other beneficiaries, this difference is important to be aware of.

Which IRA Is Right for You?

Now that you know the differences between a Roth and Traditional IRA, which one should you choose?

Ultimately, this article is for educational purposes only. I don’t know your situation, and this isn’t financial advice. Always consult a qualified financial professional for specific guidance.

In general, however, a Roth IRA is a better choice if you think your tax bracket will be higher when you retire than it is now. This is because you can contribute post-tax money at a lower tax rate and then withdraw those funds tax-free in retirement.

If you think your tax bracket will be lower when you retire than it is now, a Traditional IRA makes more sense. You’re better off getting those tax benefits now and then paying a lower tax rate on the money you withdraw when you retire. Furthermore, a Traditional IRA may be your only option if your income is above a certain threshold.

Start Saving for Retirement Today

I hope this article has helped clarify the differences between Roth and Traditional IRAs. While one plan may be better than the other for your specific situation, the most important thing is to start saving for retirement ASAP.

Don’t get so caught up in choosing the “right” plan that you never pick one. Contributing to any retirement plan is better than not contributing at all.

Looking to open a Roth or Traditional IRA? You can open one through M1 Finance with an initial deposit of just $500. Get started below:

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