Traditional vs Roth IRAs- What's the Difference

When it comes to saving for retirement, there are two main types of IRAs: Traditional and Roth. They offer different tax benefits, so it's important to understand the difference before you decide which is right for you. Here's a look at the key differences.

Taxes:

Traditional IRAs offer a tax deduction for your contributions. That means you don't pay taxes on that money you put into your IRA until you withdraw it during retirement.  This can be a helpful way to reduce your taxable income during your working years. However, when you retire and start making withdrawals, you will have to pay taxes on that money and that has to start no later than the age of 70 ½.

A Roth IRA, allows you to contribute post-tax dollars (meaning you've already paid taxes on them), but all withdrawals are tax-free in retirement. Roth IRAs have no required minimum distributions, so you can leave the money in your account as long as you want. A Roth IRA can be a great option if you expect to be in a higher tax bracket when you retire. Roth IRAs also have more flexible withdrawal rules than Traditional IRAs.

Who is eligible for a Traditional IRA, and who is eligible for a Roth IRA? 

To be eligible for a Traditional IRA, you must meet the following criteria:

  • You must have earned income
  • The contributions cannot exceed the amount of your taxable compensation for the year
  • You must be younger than 70 ½  years old

To be eligible for a Roth IRA, you must meet the following criteria:

  • You must have earned income
  • The contributions cannot exceed the amount of your taxable compensation for the year
  • Your modified adjusted gross income (MAGI) must fall below certain limits to contribute the maximum amount: $144,000 for single tax filers and $214,000 for married couples filing jointly in 2022

If your MAGI is above these limits, you can still contribute, but your contribution limit will be reduced.

Which type of IRA is best for you, and why? 

When it comes to Traditional and Roth IRAs, there are a few things to consider to decide which is best for you. The first question to ask is whether you want to defer taxes until you withdraw money in retirement (Traditional IRA), or whether you want to be able to withdraw contributions (but not earnings) tax-free (Roth IRA). The second question is eligibility: do you meet the qualifications for a Traditional IRA, or are your MAGI limits too high for you to contribute the maximum amount to a Roth IRA?

If you want to defer taxes until retirement, then a Traditional IRA is a good option for you. Keep in mind that you will have to pay taxes on the money when you withdraw it, so make sure that you plan for this in your retirement budget. If your MAGI limits are too high for you to contribute the maximum amount to a Roth IRA, then a Traditional IRA may be a better option, since there are no income restrictions.

If you want the ability to withdraw contributions tax-free, then a Roth IRA is a good option for you. This is a great option if you think you may need access to your money before retirement. 

Keep in mind that any earnings withdrawn from a Roth IRA are subject to taxes and penalties, so make sure you understand the rules before you make any withdrawals.

Conclusion

Traditional and Roth IRAs are two different types of Individual Retirement Accounts (IRAs) that offer different types of tax advantages but it’s important to assess the entirety of your financial plan before making a decision about which IRA is right for you.  If you have further questions about IRAs or other retirement vehicles, reach out and we’d be happy to help.