The Difference Between Traditional vs. ROTH IRA
When it comes to retirement planning, two popular options are Traditional and Roth IRAs. While they share many similarities, there are some key differences that can impact your retirement savings strategy. In this blog, we'll explore the differences between Traditional and Roth IRAs so you can make an informed decision about which is right for you.
What is an IRA?
First, let's define what an IRA is. An IRA, or individual retirement account, is a type of investment account designed specifically for retirement savings. With an IRA, you can contribute up to a certain amount each year (as determined by the IRS) and your investments grow tax-free until you withdraw the money in retirement.
Traditional IRA
A Traditional IRA allows you to make tax-deductible contributions, meaning you can deduct your contributions from your taxable income each year. This can help lower your tax bill in the short term, but you'll have to pay taxes on the money when you withdraw it in retirement. Additionally, once you reach age 72, you'll be required to start taking required minimum distributions (RMDs) from your Traditional IRA. Traditional Individual Retirement Accounts (IRA), which were created in 1974, are owned by roughly 36.6 million U.S. households
Roth IRA
A Roth IRA, on the other hand, does not allow you to make tax-deductible contributions. Instead, you contribute after-tax dollars, meaning you've already paid taxes on the money you're putting into your Roth IRA. However, your investments grow tax-free and you won't owe any taxes on the money you withdraw in retirement. Additionally, there are no required minimum distributions with a Roth IRA, meaning you can leave the money in the account for as long as you want. Roth IRAs, created as part of the Taxpayer Relief Act in 1997, are owned by nearly 27.3 million households.1
Both are IRAs. And yet, each is quite different.
Up to certain limits, traditional IRAs allow individuals to make tax-deductible contributions into their account(s). Distributions from traditional IRAs are taxed as ordinary income, and if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 73, you must begin taking required minimum distributions.2,3
For individuals covered by a retirement plan at work, the deduction for a traditional IRA in 2022 is phased out for incomes between $109,000 and $129,000 for married couples filing jointly, and between $68,000 and $78,000 for single filers.4
Also, within certain limits, individuals can make contributions to a Roth IRA with after-tax dollars. To qualify for a tax-free and penalty-free withdrawal of earnings, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½
Like a traditional IRA, contributions to a Roth IRA are limited based on income. For 2022, contributions to a Roth IRA are phased out between $204,000 and $214,000 for married couples filing jointly and between $129,000 and $144,000 for single filers.5
In addition to contribution and distribution rules, there are limits on how much can be contributed each year to either IRA. In fact, these limits apply to any combination of IRAs; that is, workers cannot put more than $6,000 per year into their Roth and traditional IRAs combined. So, if a worker contributed $3,500 in a given year into a traditional IRA, contributions to a Roth IRA would be limited to $2,500 in that same year.6
Individuals who reach age 50 or older by the end of the tax year can qualify for "catch-up" contributions. The combined limit for these is $7,000.6
Both traditional and Roth IRAs can play a part in your retirement plans. And once you’ve figured out which will work better for you, only one task remains: open an account.7
* Up to certain limits
** Distributions from traditional IRAs are taxed as ordinary income, and if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 73, you must begin taking required minimum distributions.
*** To qualify, Roth IRA distributions must meet a five-year holding requirement and occur after age 59½.
1. ICI.org, 2022
2. IRS.gov, March 12, 2021. Under the SECURE Act, in most circumstances, once you reach age 73, you must begin taking required minimum distributions from a Traditional Individual Retirement Account (IRA). You may continue to contribute to a Traditional IRA past age 70½ under the SECURE Act as long as you meet the earned-income requirement.
3. Up to certain limits, traditional IRAs allow individuals to make tax-deductible contributions into their account(s). Distributions from traditional IRAs are taxed as ordinary income, and if taken before age 59½, may be subject to a 10% federal income tax penalty. Generally, once you reach age 73, you must begin taking required minimum distributions.
4. IRS.gov, 2022
5. IRS.gov, 2022
6. IRS.gov, 2022
7. The Tax Cuts and Jobs Act of 2017 eliminated the ability to "undo" a Roth conversion.
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