Understanding the Differences
Between Traditional and Roth IRAs

November 23, 2021

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 IRA is usually opened and managed by individuals themselves. 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 your income is taxed. When choosing the IRA for you, it’s important to consider whether you want to pay income taxes now or later. Put simply, Traditional IRAs let account owners pay income taxes later; Roth IRAs require account owners pay taxes up front.

 

Traditional IRA account owners deposit contributions in “pre-tax” dollars. Taxes may be paid on any amount withdrawn in retirement. Your contributions are called “pre-tax” because you deduct them from your taxable income for the tax year in which they are made. This 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 money that has already been taxed. This means you will not have to pay any taxes on the money when 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

Another key difference is eligibility requirements. For Roth IRAs, income and filing status may affect your ability to contribute, whereas Traditional IRAs offer a bit more flexibility.

 

Traditional IRA accounts allow anyone, regardless of how much money they make, to contribute. Determining if your contribution is tax-deductible depends on whether you (or your spouse, if married) have a work retirement plan, like a 401(k). If you or a spouse are covered by a retirement plan at work, then income limits to the tax-deductibility of contributions kick in. As of 2022, 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 $214,000 or more.1

 

Roth IRA accounts have strict income limits that prevent those with higher incomes from opening and contributing to an account. As of 2022, the IRS states2:

  • If you’re married filing jointly, you cannot contribute to a Roth IRA if your MAGI is $214,000 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 $144,000.

Contribution Limits

Contribution limits are the same for Traditional and Roth IRAs.

 

Traditional and Roth IRA account owners cannot contribute more than $6,000 annually if they are under 50 years old, or $7,000 if they are over 50 years old, as of 2022.3 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 both – in other words, someone under 50 could contribute a combined total of $6,000 to their Traditional and Roth IRAs, in varying proportions, but not $6,000 each. Note that you cannot contribute to a Roth IRA account if your income exceeds the limits outlined in the previous section.

 

Neither Traditional nor Roth IRA accounts have age limits for contributions thanks to the SECURE Act of 2019.4 Before the act was passed, Traditional IRA account 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, 2022 to make up to your full contribution for 2021.

 

Withdrawal Requirements

When it comes to making retirement account withdrawals (formally known as “distributions”), Roth IRAs offer more flexibility than their Traditional counterpart.

 

Traditional IRA account 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 come with a 10% early withdrawal penalty fee.5 Traditional IRA account holders must start making Required Minimum Distributions when they’re 72 years old.

 

Roth IRA account 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. Otherwise, you’ll 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 account 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. However, the rules applicable to distributions from IRA accounts can be complicated and have tax consequences.  Please speak with your tax or financial advisor to evaluate the best options for your particular circumstances.

 

The Bottom Line

 

It’s never too soon to start planning for your future. Either a Traditional or Roth IRA can be a great way to start saving for retirement, but it’s crucial to consider the different tax, eligibility, and withdrawal requirements before making a choice. Traditional IRAs may be the right fit for savers who want to take advantage of tax deductions today, and expect to have less taxable income in retirement and/or expect to exceed Roth IRA income limits. On the other hand, Roth IRAs may be a better choice for those who prefer to pay income taxes up front and enjoy more flexibility when it comes to withdrawing their contributions.

Related Articles

 

 

 

 

Accounts offered by American

Express National Bank. Member FDIC. Each depositor is insured to at least $250,000.

Learn More from FDIC.gov

*The Annual Percentage Yield (APY) as advertised is accurate as of . Interest rate and APY are subject to change at any time without notice before and after a High Yield Savings Account is opened.

 

For a CD account, rates are subject to change at any time without notice before the account is opened. Your rate will be fixed on the business day‡ we receive your completed application, provided we receive your deposit within 30 days after your application is approved. After a CD is opened, additional deposits to the account are not permitted. Early CD withdrawals may be subject to significant penalties which could cause you to lose some of your principal. Please see the Deposit Account Agreement for additional terms and conditions and Truth-in-Savings disclosures.

 

**The national rate referenced is from the FDIC's published Monthly Rate Cap Information for Savings deposit products. Visit the FDIC website for details.

 

†You are generally permitted to make up to nine (9) withdrawals or transfers out of your High Yield Savings Account during a monthly statement cycle. However, please note that there are strict rules for withdrawing money from an IRA plan (including an IRA High Yield Savings Account) before retirement age without incurring a penalty. Read More in FAQs.

 

‡For purposes of transferring funds, business days are Monday through Friday, excluding holidays. Transfers can be initiated 24/7 via the website or phone, but any transfers initiated after 7:00 PM Eastern Time or on non-business days will begin to be processed on the next business day.

 

♢Calculations are estimates of expected interest earned. Actual results may vary, based on various factors such as leap years, timing of deposits, rounding, and variation in interest rates. The first recurring deposit is assumed to begin in the second period after any initial deposit.

 

§IRA Contributions are subject to aggregate annual limits across all IRA plans held at American Express or other institutions. IRA distributions may be taxed and subject to penalties based on IRS guidelines. Required minimum distribution, if applicable, is only relevant to this IRA plan and does not take into consideration other IRA plans held at American Express or other institutions. Please see IRS.gov for more information. We recommend you consult with a financial or tax advisor when making contributions to and distributions from an IRA plan account.