Roth IRA vs. Traditional IRA
Individual retirement accounts (IRAs) are a great way to set money aside for retirement.
Published January 27th, 2021
Table of Contents
- There are two types of IRAs: Roth IRAs and Traditional IRAs.
- A Traditional IRA lets you put funds in pre-tax, while a Roth IRA’s funds have already been taxed.
- High-income taxpayers may find they aren’t able to contribute to a Roth IRA. Traditional IRAs also have income limits where tax deductible contributions are no longer allowed.
Individual retirement accounts (IRAs) are a great way to set money aside for retirement. But if you’re considering an IRA, you’ll have two choices: Roth or Traditional. Weighing the differences between a Roth versus Traditional IRA makes it clear that a Traditional IRA may be better for those in higher income tiers.
When you’re considering a Traditional IRA vs Roth IRA, the biggest difference is the way they’re taxed. With a Traditional IRA, money is put in before taxes have been taken out on it. Your Roth IRA contributions have already been taxed. For some, a Traditional IRA is a better option, but many others will benefit from the tax-free contributions of a Roth IRA.
Roth IRA vs. Traditional IRA: Overview
Individual retirement accounts (IRAs) have long served as a great alternative to 401(k) retirement accounts, which are set up by an employer. You can set up an IRA on your own, going through a broker or your favorite lender. Traditionally, those third-parties have many more investment selections to choose from than in an employer-based plan like a 401(k).
But if you’re choosing between a Roth IRA or Traditional IRA, there are some contribution, taxation, and withdrawal differences to consider.
The biggest difference between a Traditional IRA vs Roth IRA is the way you pay taxes. But there are other tax differences between the two. This table breaks it down:
|Roth IRA||Traditional IRA|
|Taxes on contributions||Money is put in after taxes are taken||Money is contributed pre-tax|
|Taxes on Withdrawals||Distributions are not taxed as long as you meet the requirements||Distributions are taxed as ordinary income|
|Tax Deductibility||You cannot claim your Roth IRA contributions on your taxes||Some contributions are tax-deductible|
Another difference between Roth IRA and Traditional IRA is the deductibility. Depending on your income, the IRS may allow you to deduct some of your Traditional IRA contributions on your taxes. For 2021, the deduction limits for a Traditional IRA are as follows:
|Single filers||Married filing jointly||Contribution limit|
|$66,000 or less||$105,000 or less||Your full contribution|
|$66,0001-$75,999||$105,001-$124,999||A reduced amount based on your exact income|
|$76,000 or more||$125,000 and up||No IRA deductions allowed|
When it comes to how much you can contribute, there’s no difference between Roth and Traditional IRA. Both plans have a yearly limit regulating how much you can contribute. This can change from one year to the next.
For 2021, both types of IRA allow contributions of up to $6,000 per person. If you’re aged 50 or older, you can contribute up to $7,000, giving you a $1,000 catch-up contribution.
But when you’re looking at the Roth IRA definition, it’s important to note that there are some income limits that may apply. You won’t face this with a Traditional IRA.
Another major consideration if you’re choosing either Roth or Traditional IRA is your income. Look at your anticipated modified adjusted gross income based on your filing status to see what you can contribute to a Roth IRA. Some higher earners can’t contribute to a Roth IRA at all. There is no income limit on the ability to make contributions to a Traditional IRA. However, there are income limits on whether those contributions will be tax-deductible or not.
|Single filers||Married filing jointly||Contribution limit|
|Under $125,000||Under $198,000||Up to $6,000 ($7,000 if you’re age 50 or over)|
|$125,000-$139,999||$198,000-$207,999||A reduced amount based on your exact income|
|$140,000 and up||$208,000 and up||No Roth IRA contributions allowed|
The magic number to know if you have either a Traditional or Roth IRA is 59½. You’ll ideally leave the money in your IRA account until you reach that age. Once you’re 59½, you can take the money out penalty-free. Before 59½, you’ll pay a 10 percent penalty.
One of the Roth IRA advantages, though, is that the 10 percent penalty only applies to the growth you’ve made on the money you put in. You paid taxes the first time around, so you gained nothing by having the IRS hold it for you for all those years. But the money you made will both be taxed and penalized for early withdrawals.
With a Traditional IRA, you didn’t pay taxes when you contributed the money, so you’ve had the funds in a tax shelter of sorts for the years they’ve been in. This means every dime you take out will be taxed when you withdraw the funds--both the original investment and your earnings.
Another note when looking at withdrawals from an IRA that is Roth versus Traditional IRA is that Roth IRAs don’t require you to take the money out at any point in your lifetime. Traditional IRAs, on the other hand, require that you take required minimum distributions (RMDs) by the age of 72. If you reached 70½ before the rules changed in 2020, you were required to start taking it out then to avoid penalties.
The benefits of an IRA are that you can set them up on your own, without an employer’s help, and that you have a wider range of investment options. If you’re looking for a way to reduce your taxable income now, a Traditional IRA might be a better option for you. But a Roth IRA gives you access to tax-free funds when you retire, which may just be when you need tax relief the most. It’s in your best interest to talk to a Certified Financial Planner® to discuss your particular circumstances and goals for retirement to help determine which retirement account may be best for you.
Cashing Out your 401(k)
Understanding Roth 401(k)s
Roth IRA Basics