Traditional and Roth IRA accounts are the most popular types of individual retirement accounts (IRAs). They have many advantages and a few drawbacks for retirement savers.

Traditional and Roth IRAs: An Overview

The IRA was created decades ago as defined benefit pension plans were declining. Becoming more popular as workers started to take control of their own retirement savings, the IRA offers individuals an opportunity to save for retirement in a tax-advantaged account.

Key Takeaways

  • Traditional and Roth IRAs are popular retirement accounts and easy to set up.
  • Both offer a tax-advantaged way to save and invest for retirement.
  • There are, however, limits to how much you can contribute and penalties for early withdrawals.

In a traditional or Roth IRA account, you can invest in all sorts of traditional financial assets such as stocks, bonds, exchange-traded funds, and mutual funds. You can invest in a wider range of investments through a self-directed IRA (one in which you the investor, not a custodian, makes all the investment decisions)–commodities, precious metals, real estate, or even peer-to-peer loans. However, no matter which type of IRA, you may not invest in life insurance or collectibles such as artwork, rugs, antiques, gems, and stamps.

IRA accounts are relatively easy to set up, but the rules that govern these accounts vary. While they offer tax benefits, there are limits to how much you can contribute.

Benefits of Traditional and Roth IRAs

IRAs offer several distinct advantages, including:

Tax-Free Growth

Both Roth and traditional IRAs offer tax-free growth of assets. This means that once the money is in the account, no taxes are levied on the dividends or capital gains that the investments earn.

Tax Deductions

While Roth IRA contributions are made with after-tax dollars, traditional IRA contributions are made with pre-tax dollars. This means they can be deducted from your income—in most cases—although there are certain limitations.

The deductibility is determined by income levels as well as whether you are covered by a workplace retirement account, such as a 401(k). The IRS explains the traditional IRA deductibility rules for 2019 as follows for those workers who are covered by a workplace retirement account:

If Your Filing Status Is... And Your Modified AGI Is... Then You Can Take...
single or
head of household
$64,000 or less a full deduction up to the amount of your contribution limit
  more than $64,000 but less than $74,000 a partial deduction
  $74,000 or more no deduction
 

married filing jointly or qualifying widow(er)

 

$103,000 or less

 

a full deduction up to the amount of your contribution limit

  more than $103,000 but less than $123,000 a partial deduction
  $123,000 or more no deduction
married filing separately less than $10,000 a partial deduction
  $10,000 or more no deduction

If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the "single" filing status.

Both traditional and Roth IRAs have the same contribution deadline. You are allowed to contribute to your IRA during the entire calendar year and up to April 15 of the following year.

Drawbacks of Traditional and Roth IRAs

While the pros of IRAs generally outweigh the cons, there are a few drawbacks to be aware of.

Contribution Limits

IRAs have strict contribution limitations. To contribute to an IRA, you or your spouse need earned income. For 2019, the maximum contribution amount per person is $6,000—$7,000 if you’re age 50 or older. After you reach age 70½, you can’t contribute to a traditional IRA, although you may still add to a Roth IRA. But if your modified adjusted gross income (MAGI) exceeds a certain level, you may not be able to contribute to a Roth IRA.

2019 Roth IRA Income Contribution Limts
 

Filing Status

 

Modified adjusted gross income (MAGI)

 

Contribution Limit

 

Single/Head of Household

 

< $122,000

 

$6,000 or $7,000 if 50 and older

   

≥ $122,000 but < $137,000

 

Partial contribution

   

≥ $137,000

 

Not eligible

 

Married (filing joint returns)

 

< $193,000

 

$6,000 or $7,000 if 50 and older

   

≥ $193,000 but < $203,000

 

Partial contribution

   

≥ $203,000

 

Not eligible

 

Married (filing separately)

 

< $10,000

 

Partial contribution

   

≥ $10,000

 

Not eligible

If you were married filing separately and you did not live with your spouse at any time during the year, your tax status is single.

Penalties

Since the IRA is intended for retirement, there are often certain penalties if you take out your money before retirement age.

With the traditional IRA, you face a 10% penalty on top of the taxes owed for any withdrawals before age 59½. With the Roth IRA, you can withdraw a sum equal to your contributions penalty and tax-free at any time. However, you can only withdraw earnings without getting dinged if you’ve held the account for five years and have reached age 59½.

There are a few exceptions to these early withdrawal rules. The most popular include:

  • Withdrawals up to $10,000 to help pay for a first home for yourself, your spouse, children or grandchildren
  • Withdrawals to pay for college expenses for the same

Required Withdrawals

There are mandatory withdrawals for your traditional IRA called required minimum distributions (RMD), starting when you reach age 70½. The amount of the withdrawal is calculated based on your life expectancy and it will be added to that year's taxable income. There is a 50% penalty, plus taxes owed, if you fail to take the RMD.

A popular benefit of the Roth IRA is that there is no required withdrawal date. You can actually leave your money in the Roth IRA to let it grow and compound tax free indefinitely. What's more, any money you do choose to withdraw is tax free.