Individual Retirement Arrangements (IRAs) are popular retirement savings plan options with important tax advantages, often used by individuals who don’t have access to an employer’s 401(k). As the name suggests, an individual usually opens and manages an IRA. However, there are several types of IRA to consider. The most common are Traditional and Roth IRAs, which have different eligibility criteria, withdrawal requirements, and – most importantly – different rules about how your income is taxed.
Understanding the differences between Traditional and Roth IRAs can help you make the right choice for your future retirement needs. The following is general information on Traditional and Roth IRAs. Please speak with your tax/financial advisor for questions related to your specific tax/financial situation.
Income Tax Rules
Perhaps the most notable difference between Traditional and Roth IRAs is when you pay income taxes. As you choose an IRA, you’ll decide whether to pay income taxes now with a Roth IRA or later with a Traditional IRA.
Traditional IRA contributions are made with “pre-tax” dollars. Your contributions are called “pre-tax” because you deduct them from your taxable income for the tax year in which they are made. Taxes will need to be paid on any amount withdrawn in retirement. A Traditional IRA is generally most favorable when you are closer to retirement and/or you expect your tax rate to be lower when you withdraw.
Roth IRA deposits are made with after-tax dollars. Since you pay income taxes upfront, you won’t have to pay any taxes on the money if you choose to make withdrawals in retirement. However, contributions to Roth IRAs are not tax deductible. This is generally most favorable when you are further from retirement and/or you expect your tax rate to be higher when you withdraw.
Eligibility Requirements and Income Limits
For Roth IRAs, income and filing status may affect your ability to contribute, whereas Traditional IRAs offer a bit more flexibility.
Traditional IRAs allow anyone, regardless of how much money they make, to contribute. But determining if your contribution is tax-deductible depends on whether you (or your spouse, if married) have a workplace retirement plan, like a 401(k). If you or your spouse are covered by a retirement plan at work, then income limits to the tax-deductibility of contributions kick in. As of 2023, for example, if you are not covered by a plan at work but your spouse is, and you’re filing jointly, no deduction is allowed if your modified adjusted gross income (MAGI) is $228,000 or more.1
Roth IRAs have strict income limits that prevent those with higher incomes from opening and contributing to an account. As of 2023, the IRS states2:
- If you’re married filing jointly, you cannot contribute to a Roth IRA if your MAGI is $228,000 or more.
- If you’re married filing separately and lived with your spouse at any time during the year, you cannot contribute to a Roth IRA if your MAGI is greater than $10,000.
- If you’re single, head of household, or married filing separately and did not live with your spouse at any time during the year, you cannot contribute to a Roth IRA if your MAGI is greater than $153,000.
Contribution limits are the same for Traditional and Roth IRAs.
Traditional and Roth IRA owners cannot contribute more than $6,500 annually if they are under 50 years old or $7,500 if they are over 50 years old, as of 2023.3 If you have both a Traditional and a Roth IRA in your name, or multiple IRAs at one or more banking institutions, these contribution limits are the total for all IRAs – in other words, someone under 50 could contribute a combined total of $6,500 to their Traditional and Roth IRAs, in varying proportions, but not $6,500 each. Note that you cannot contribute to a Roth IRA if your income exceeds the limits outlined in the previous section.
Neither Traditional nor Roth IRAs have age limits for contributions thanks to the SECURE Act of 2019.4 Before the act was passed, Traditional IRA owners could only make contributions up to age 70½.
For both Traditional and Roth IRAs, the contribution deadline for each tax year usually corresponds with your tax return filing deadline. For example, you’ll typically have until April 15, 2024, to make your full contribution for 2023.
When it comes to making retirement account withdrawals (formally known as “distributions”), Roth IRAs offer more flexibility than their Traditional counterpart.
Traditional IRA owners who make withdrawals after age 59½ will be taxed at their then-current income tax rate. Withdrawals made before age 59½ will be taxed similarly, plus a 10% early withdrawal penalty.5 Traditional IRA owners must start taking Required Minimum Distributions when they’re 72 years old (73 if someone turns 72 after December 31, 2022).6
Roth IRA owners can withdraw contributions at any age, tax and penalty-free because they already paid income tax on that money before it was contributed. To withdraw earnings from your Roth IRA without owing taxes or penalties, you must be at least 59½ years old and the account must be at least five years old.7 Otherwise, you may have to pay income taxes and a 10% early withdrawal penalty on the earnings withdrawn.
It’s worth noting that both Traditional and Roth IRA owners may be able to avoid early withdrawal penalties in certain circumstances, like using withdrawals to pay for qualified first-time home buyer expenses or eligible education expenses, up to certain limits.8 However, the rules applicable to distributions from IRAs can be complicated and have tax consequences. Please speak with your tax or financial advisor to evaluate the best options for your particular circumstances.