What is the Difference between a Roth and a Traditional IRA?

Posted on Dec. 21, 2021

Both traditional individual retirement arrangements, commonly referred to as IRAs and Roth IRAs are good retirement savings options. Each has key differences to consider when determining which is the best option for you.1

Differences between traditional and Roth IRAs include tax benefits when in both the contribution and withdrawal phases, eligibility criteria, forced disbursements, and more. Below is an overview comparing and contrasting traditional and Roth IRAs:


Income Limits, Roth IRA

The IRS has rules in place for IRAs, so determine if you are even eligible for a Roth by looking at your current income. Limits are based on your modified adjusted gross income (MAGI). If you make less than $125,000 or have a household combined income less than $198,000, you can contribute up to $6,000 annually ($7,000 if 50 or older).2 See a full chart on contribution limits and where they cut off. 

If your income is too high for you to contribute to a Roth IRA, don't worry. There's something called a "backdoor" Roth IRA that allows you to access this savings vehicle. Here's how:

There are no restrictions to converting a traditional IRA to a Roth. High-income earners can move contributions to a traditional IRA that did not qualify for the pre-tax deduction. If you only have nondeductible IRA contributions, converting is very simple and without tax consequences.


Traditional IRA Roth IRA
Overview
  • Allows you to make pre-tax contributions
  • Consider a traditional IRA if you expect to be in a higher tax bracket when you begin taking withdrawals.
  • Allows you to make after-tax contributions
  • Consider a Roth IRA if you expect to be in the same or a lower tax bracket when you begin taking withdrawals.
Pros
  • Contributions may reduce taxable income in the year they are made.
  • In retirement, qualified withdrawals are tax-free.
  • Contributions may be withdrawn at any time.
Cons
  • In retirement, distributions are taxed as ordinary income.
  • Contributions have no immediate tax benefit.
  • Individuals with higher incomes may not be able to contribute.
Taxes
  • Contributions grow tax-deferred.
  • Contributions may be tax-deductible.
  • Contributions grow tax-free.
  • Contributions are not tax-deductible.
Contributions
  • Contributions are generally made from pre-tax dollars.
  • Anyone with earned income can contribute.
  • For 2021, the maximum contribution is $6,000, or $7,000 if you are over age 50.
  • Contributions come from after-tax dollars.
  • High-income individuals are not eligible to contribute.
  • For 2021, the maximum contribution is $6,000, or $7,000 if you are over age 50.


IMAGE: Woman comparing citrus fruit in grocery store.

Income Limits, Traditional IRA

Your income level determines the tax deduction eligibility of traditional IRA contributions. However, income limits only apply if you or your spouse has a retirement plan through work. For single taxpayers, the ability to deduct upfront taxes ends if your income is $76,000 or more, and $125,000 or more for married filing joint. A full chart can be found at the links below for those covered by a workplace retirement plan, as well as those not covered:

As a general rule, Roth IRAs are the best option for most savers. It is hard to go wrong with a Roth IRA unless you need a tax break now. Here are a few reasons why:

  1. Early withdrawals are easier with a Roth IRA

    While early withdrawals from any retirement fund are discouraged, if you find yourself needing to dip in, the Roth allows access to your contributions — not earnings — at any time without a tax or early withdrawal penalty. Traditional IRAs are not as flexible. Expect a 10% early withdrawal penalty, and any funds you withdraw will be considered income and taxed at your current rate.

  2. A Roth has fewer rules for retirees.

    Whether you want to or not, traditional IRAs require you to start taking minimum distributions by age 72. Unless you inherited a Roth, there is no required minimum distribution at any age. You can let your money keep growing in the account for as long as you wish.

  3. A Roth IRA offers more after-tax money.

    In a traditional IRA, the tax benefit occurs each year you contribute. If you don’t take those tax savings and reinvest them into the fund, they are likely to be spent elsewhere. Unless you need the upfront tax break or are extremely vigilant with your savings, you'll end up with more money when you opt for the tax benefit at the end with a Roth IRA.

  4. Tax diversification.
    If you are participating in a workplace 401(k), directing a portion of your retirement investment into a Roth gives you tax diversification with both pre- and post-tax funds and options for handling your tax burden in retirement.

Before you decide for yourself, weigh the pros and cons of each, and consult your tax advisor. A traditional IRA's primary advantage is the upfront tax break, which may be a great incentive for someone who might not otherwise save for retirement. Suppose you don't need that immediate tax break. In that case, it's hard to ignore the benefits of the Roth: Tax-free withdrawals in retirement and contributions can be withdrawn at any time without penalty, should you need them.

Texell offers both Roth and Traditional IRA accounts, as well as related Term Share Certificates. Learn more about our IRAs, and access our calculators to see firsthand the savings you could realize with these retirement savings vehicles. 


If you wish to comment on this article or have an idea for a topic we should cover, we want to hear from you! Email us at editor@texell.org.
 
1This article is for educational purposes only. Texell does not offer investment or advisory services, nor does it offer tax advice.
The income levels in this article are for 2021

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