Roth IRA vs. Traditional IRA: An Overview

Individual retirement accounts (IRA) are tools used to set aside and invest savings for retirement. There are several types of IRAs as of 2018: traditional IRAs, Roth IRAs, SIMPLE IRAs, and SEP IRAs, with Roth and tradition being the most common

But which is the better choice, Roth or traditional? The key differences generally come down to taxes: Do you want to pay them now or later?

Key Takeaways

  • Both Roth and traditional IRAs are retirement savings and investment vehicles.
  • Roth IRA contributions are made with post-tax dollars, while traditional IRA contributions are made with pre-tax dollars.
  • Traditional IRA distributions are treated as income, while Roth IRA distributions are not taxed.
  • Roth IRAs have income restrictions that may disqualify some people from participating.

Roth IRA

Roth IRAs are quite similar to traditional IRAs in many ways. Both offer a range of investment options for retirement savings, and the contribution limits for Roth and traditional IRAs are the same. For tax year 2019, for example, you can contribute up to $6,000 to your IRA, plus an additional $1,000 catch-up contribution if you reach age 50 or older by the end of the tax year.

One major difference is that Roth IRA contributions are made with after-tax dollars. Contributions to Roth IRAs are never deductible. But this means that investment income is treated differently. Qualified Roth IRA distributions are tax free and penalty free. Roth IRA distributions are qualified if they meet the following two requirements:

  • The distributions are taken no earlier than five years after you fund your first Roth IRA. This five-year period begins with the tax year for which the first contribution is made.
  • The distribution is taken as a result of any one of the following:
  • You have reached age 59½.
  • You are disabled.
  • Your beneficiary receives the distribution upon your death.
  • The amount is used to purchase a first home (subject to a lifetime limit of $10,000).

From a general tax perspective, the Roth IRA is the better choice if your tax rate during retirement will not be lower than your current tax rate, as the Roth IRA allows you to pay the taxes now and receive tax-free distributions when your income tax rate is higher.

Another big advantage for Roth IRAs is deciding when to take money out. If you do not ever want to be required to start distributing your retirement assets at any time, you need to consider the IRA rules for required minimum distributions (RMDs). Traditional IRAs are subject to RMD rules, whereas Roth IRAs are not.

Your income may determine whether you should fund a Roth or traditional IRA. If your income exceeds certain limits, you may not contribute to a Roth IRA. In addition, your Roth IRA contribution limit may be lowered if your income falls within certain ranges. Consult with your tax advisor to determine the maximum amount you may contribute to a Roth IRA.

For 2018, “taxpayers who are married filing jointly can make full Roth IRA contributions if their modified adjusted gross income (MAGI) is below $189,000. The right to contribute to Roth accounts is phased out for such taxpayers earning between $189,000 and $199,000. Single taxpayers are phased out starting at $120,000 of modified AGI and fully phased out at $135,000 of MAGI,” explains Andrew K. Cashman, comprehensive wealth advisor, Quincy, IL.

In 2019, you can only contribute to a Roth IRA if your MAGI is below $137,000 for single filers, or $203,000 for married couples filing jointly.

Traditional IRA

A traditional IRA account is a retirement savings and investment vehicle, like a Roth IRA. However, one of the major factors for deciding between a Roth and traditional IRA is your eligibility to deduct traditional IRA contributions and, in turn, get a tax break for the year you make the contribution. Your eligibility to deduct traditional IRA contributions, however, depends on whether you meet certain requirements.

For 2019, a traditional IRA is fully tax deductible if you or your spouse is not participating in a retirement plan at work, regardless of income, or even if you or your spouse do participate but your income is less than $74,000 for an individual or $123,000 if filing jointly. "Otherwise, you can still make a contribution but the tax deductibility is quickly phased out above those levels,” says Dallas, TX-based Dan Stewart CFA®, president, Revere Asset Management, Inc. Contributions to Roth IRAs are never deductible.

Because contributions were made pre-tax, distributions from a traditional IRA are treated as ordinary income and may be subject to income taxes. Furthermore, the distributed amount may be subject to early distribution penalties if the amount is withdrawn while you are under the age of 59½. With a traditional IRA, you must begin to take RMDs by April 1 of the year following the year you reach age 70½. This means you must gradually reduce your IRA balance and add the distributed amount to your income, even if you are not in need of the funds.

If you want to be able to contribute to your IRA for as long as you like, you need to consider the age limits placed on IRA contributions. You may not make a participant contribution to a traditional IRA for the year you reach 70½ and any time after that. For Roth IRAs, there is no age limit.

Special Considerations

If you are eligible to contribute to both types of IRAs, you may divide your contributions between a Roth and traditional IRA. However, your total contribution to both IRAs must not exceed the limit for that tax year (including the catch-up contribution if you're age 50 or over).

Both Roth IRAs and Traditional IRAs can be found at most brokers, though some brokers may have more robust tools and reporting than others. With the variation between the different brokers, we have made lists of the best brokers for IRAs and best brokers for Roth IRAs.

If you decide to split your contributions between both types of IRAs, you may choose to contribute the deductible amount to your traditional IRA.

Before splitting your IRAs, however, consider additional fees, such as maintenance fees charged by your IRA custodian/trustee for maintaining two separate IRAs.

“It typically makes more sense to consolidate your retirement accounts of the same type (pre-tax vs. after-tax or Roth). This saves on fees and makes your life easier from a tracking perspective,” says Kirk Chisholm, wealth manager at Innovative Advisory Group in Lexington, MA.

Note also that placing bulk trades into one IRA instead of placing separate trades in separate IRAs could help you save on trade-related fees. Finally, consider the short-term benefits as well as the long-term benefits and decide which outweighs the other.

Key Differences

The following chart summarizes the similarities and differences between Roth and traditional IRAs:

  Roth IRA Traditional IRA
Contribution Limit The year's regular contribution limit plus a catch-up contribution for those at least 50 years old by year end. The year's regular contribution limit plus a catch-up contribution for those at least 50 years old by year end.
Deductibility Contributions are never deductible. Contributions may be deductible, depending on tax-filing and active-participant statuses, as well as income amount.
Age Limitation No age limitations on contributions. No contributions allowed after and for the year the taxpayer attains age 70½.
Tax Credit Available for “saver’s tax credit.” Available for “saver’s tax credit.”
Income Caps for Contributions Income caps may prevent taxpayers from contributing. No income caps will prevent taxpayers from contributing.
Treatment of Earnings on IRA Investments Earnings grow tax deferred. Qualified distributions are tax free, including distribution of earnings. Earnings grow on a tax-deferred basis. Earnings are added to taxable income for the year distributed.
Distributions Rules Distributions may be taken at any time. Distributions are tax and penalty free if qualified. Distributions may be taken at any time. Distributions will be treated as ordinary income and may be subjected to an early-distribution penalty if withdrawn while the owner is under the age of 59½.
Required Minimum Distribution Owners are not subject to the RMD rules. However, beneficiaries are subject to the RMD rules. IRA owners must begin distributing minimum amounts beginning April 1 of the year following the year they turn age 70½. Beneficiaries are also subject to the RMD rules.

For some taxpayers, their eligibility to deduct traditional IRA contributions is the main deciding factor in choosing between a Roth and traditional IRA. However, being eligible to deduct your contribution does not mean that the traditional IRA is your better choice. Consider whether the benefits of the Roth IRA, such as freedom from the RMD rules and taxes and penalty-free distributions, outweigh the benefits of a deduction. This Roth vs. traditional IRA calculator will help you decide which account could be better.