The biggest difference in a Roth vs. Traditional IRA is that Roth IRA contributions are taxed upfront instead of at the time of being withdrawn. Both accounts have the same contribution limits, investment options, and providers. However, Roth IRAs are better if you plan to make more money at retirement age than you do now.
Roth IRA vs. Traditional IRA Comparison
|Tax-Free Withdrawals After 59 ½|
|Required Minimum Distributions|
Starting at 70 ½
|Catch-Up Contribution Limit for Investors over 50|
*The total limit for Roth IRAs and Traditional IRA contributions is $5,500 for 2018 (+$1,000 in catch-up contributions if you’re over 50). Account holders who have both a Roth and Traditional IRA can’t contribute more than $5,500 in aggregate.
Roth vs. Traditional IRA Differences
When weighing a Roth IRA vs. Traditional IRA, there aren’t many significant differences to consider. Both have the same contribution limits, the same potential investment options, and the same providers. The biggest difference between Roth and Traditional IRAs is that contributions to a Traditional IRA are tax-deductible, but contributions to a Roth IRA aren’t.
The biggest differences between Roth and Traditional IRAs are:
- Income Tax Bracket: Most people plan to earn less income in retirement because they won’t have a salary. In this case, they should have a lower future tax rate and would benefit more from the upfront tax deductions of Traditional IRA contributions.
- Afford to Contribute: If you’re on a tight budget and you can’t afford to contribute without the benefit of tax-deductible contributions, then the question of current or future tax rates is irrelevant.
- Required Minimum Distributions: This is only a concern for some investors, but Traditional IRAs have required minimum distributions starting at 70½ while Roth IRAs do not. In a Roth, you can still withdraw funds, but if you don’t need the money for income, you can let it continue to grow tax-free.
While contributions to a Traditional IRA are tax-deductible, withdrawals from a Traditional account are taxed as ordinary income. Roth IRA contributions, on other hand, are taxed upfront but distributions are tax-free. Where Traditional IRAs provide an upfront tax-benefit of deferring taxes, Roth IRAs provide tax-free growth and tax-free distributions during retirement.
When to Use a Roth IRA
A Roth IRA is a good option if your budget allows for after-tax contributions and your tax rate in retirement may be higher than it is now. You must also meet certain eligibility requirements, including Roth IRA income limits, in order to contribute.
“Contributions to a Roth IRA are not tax-deductible, but qualified withdrawals are tax-free and all your earnings are also tax-free. In order to make Roth IRA contributions, you need to earn taxable income. For these purposes, taxable income includes wages, salaries, tips, or other payments for work. It does not include unemployment, child support, alimony, interest and dividends, Social Security, or other retirement income. You can contribute to a Roth IRA at any age, even if you’re over 70.”
– Josh Zimmelman, President, Westwood Tax & Consulting
If you have a Roth 401(k) at work, you should use that instead of a Roth IRA. This is because Roth 401(k) accounts are typically lower cost, offer employer-matching contributions, and have higher contribution limits than Roth IRAs. Roth 401(k)s also aren’t subject to Roth IRA income limits that may keep you from being able to contribute.
Some factors that may make a Roth IRA right for you include:
- Don’t Have a Roth 401(k) – If you have access to a Roth 401(k) at work, the contribution limits are far higher and costs are typically lower
- Meet Roth IRA Income Limits – Make sure that you’re eligible to contribute to a Roth IRA based on your income
- Low Current Tax Rate – If you wouldn’t get much benefit from tax-deductible contributions right now, a Roth IRA may be right for you
- Maximizing IRA Contributions – You should already have another retirement account and experience investing before you open a Roth IRA
- Expect a Higher Retirement Tax Rate – If your income may be higher in retirement, a Roth IRA may be a great option for lowering your tax liability during retirement
If you’d like to learn more about what a Roth IRA is, how it works, or Roth IRA pros and cons, be sure to check out our ultimate guide to Roth IRA Rules, Contributions Limits, and Deadlines.
When to Use a Traditional IRA
A Traditional IRA is ideal if you don’t have access to an employer-sponsored retirement plan at work and still want the benefits of tax-deductible contributions. While Traditional IRA contributions are tax-deductible, distributions are taxed as income—so a Traditional IRA makes sense if you expect to make less money in retirement than you do today.
Some factors that may make a Traditional IRA appropriate for you are:
- No Employer-Sponsored Retirement Plan – If you’re eligible for a 401(k) at work, you may not be able to contribute to an IRA because of IRA income limits—your contributions to an employer-sponsored plan may exceed IRA contribution limits. The costs of an employer-sponsored plan are also typically lower than a Traditional IRA and many employer plans offer matching contributions.
- Want a Tax Deduction Right Now – If you can benefit from tax-deductible IRA contributions, they can reduce your short-term tax liability.
- New Investor – If you’re just starting out, a Traditional IRA is a great way to start saving and investing.
- Expect a Lower Retirement Tax Rate – Many people’s incomes drop off during retirement and their income tax rate falls, which can make a Traditional IRA very beneficial.
To learn more about Traditional IRAs, how they work, or Traditional IRA pros and cons, visit our ultimate guide to Traditional IRA Rules, Contribution Limits, and Deadlines.
When to Diversify with Both a Roth IRA vs. Traditional IRA
If you qualify for a Roth and Traditional IRA, using both may be your best option. That way, you can enjoy some benefits from each. Every year you have up to $5,500 in IRA contribution limits that you can divide between taxable contributions to a Roth IRA vs. tax-deductible contributions to a Traditional IRA.
In order to diversify with both a Roth and Traditional IRA, it’s important to make sure that you’re eligible for both accounts. This typically means that you aren’t eligible for an employer-sponsored retirement plan at work and also that you don’t exceed Roth IRA income limits.
“Contributions to Roth IRAs are not deductible, but the income build-up is never taxable. Traditional IRAs yield a current tax deduction but are fully taxable on withdrawal. Roth IRAs are very advantageous when they are started early on in life. The lifetime tax free build-up is a very good tax-free wealth builder.”
– Patrick R. Colabella, CPA, Associate Professor, St. John’s University
Roth and Traditional IRA Contributions
Each year, investors who qualify can contribute up to $5,500 per year to an IRA (plus $1,000 in catch-up contributions if you’re over 50). The contribution limit is the same if you contribute to a Traditional IRA vs. Roth IRA or both. You can decide how to divide your $5,500 in contributions.
Dividing Roth vs. Traditional IRA Contributions
If you decide to use Roth and Traditional IRAs together, you’ll have some flexibility with required minimum distributions in retirement (which you’ll have to take from your Traditional IRA but not your Roth). Most importantly, you’ll give yourself access to some tax-free Roth distributions during retirement while still enjoying some tax breaks upfront.
Roth vs. Traditional IRA Examples
Let’s say you plan to contribute $50,000 to a retirement account over the course of 20 years—from the time you’re 30 until you’re 50. Depending on whether you use a Roth or Traditional IRA, your contributions may or may not be tax-deductible. Your account will then grow tax-free until you start taking withdrawals.
Regardless of whether you use a Roth vs. Traditional IRA, you can’t withdraw money from your account before age 59½ without incurring penalties or additional taxes. Even after 59½, your withdrawals may be taxed depending on what kind of account you use. You may also have to start taking a required minimum distributions once you reach 70½.
Roth IRA Contribution & Withdrawal Example
Using a Roth IRA, you have to pay between 15 percent and 25 percent income tax on all contributions you make to the account. However, if you’re in tax bracket over 25 percent, you probably aren’t eligible to contribute to a Roth IRA. Once you make contributions to a Roth IRA, your account grows tax-free. You can also withdraw money from a Roth IRA tax-free after age 59½.
After age 59½, the Roth IRA owner could start taking distributions (but they wouldn’t have to). However, at no point would any taxes be owed on any of their distributions—unless they withdraw money before age 59½, in which case a 10 percent penalty would be imposed.
Traditional IRA Contribution & Withdrawal Example
With a Traditional IRA, any contributions that you make to your account would be tax-deductible—meaning that you wouldn’t have to pay income tax on any of your contributions. Once you contribute, your account would also grow tax-free. However, once you start taking withdrawals after 59½, you would have to pay income tax on all withdrawals.
Unlike a Roth IRA, if a Traditional IRA owner still had money in the IRA at age 70½, that remaining balance would be subject to required minimum distributions going forward. The amount of those required distributions would be based on an individual formula and the balance in their account.
Diversified Roth and Traditional IRA Example
Continuing with the example of an investor who contributes $50,000 over 20 years, this time let’s assume that they split their contributions evenly between a Roth vs. Traditional IRA. This investor would probably pay between $4,000 and $8,000 in taxes upfront on the Roth portion of their contributions.
However, this investor would also have been able to deduct $25,000 in Traditional IRA contributions from their taxable income over the course of those 20 years. In both their Roth vs. Traditional IRAs, contributions would have grown tax-free until they started taking withdrawals.
When this investor got to retirement, they would have accumulated a balance (again, let’s say $150,000) spread between Roth and Traditional IRAs. Assuming that half of their $150,000 was in a Traditional IRA and half in a Roth, they’d likely pay about $12,000 to $22,000 in taxes during their retirement on their Traditional IRA withdrawals only.
Meanwhile, this investor wouldn’t be taxed on any of their Roth IRA distributions if they decided to take any—they could always leave their Roth IRA balance untouched and pass it on to heirs.
How a Roth IRA vs. Traditional IRA Works
Roth IRAs and Traditional IRAs are very different in terms of tax treatment. However, in many other respects, these two account types are very similar. They have the same investment options, the same contribution limits, and the same providers. The biggest difference between them is that Roth IRAs are taxed upfront and Traditional IRAs are taxed later.
How a Roth IRA Works
A Roth IRA is structured just like a Traditional IRA except that Roth IRA contributions aren’t tax-deductible. Instead, contributions are still treated as taxable income. A Roth IRA grows tax-free, just like a Traditional IRA. However, Roth IRA distributions are also tax-free, although early withdrawals are still subject to a 10 percent penalty.
Roth IRA pros and cons are numerous. For example, Roth IRAs allow tax-free distributions after age 59½ but they aren’t subject to required minimum distributions. Roth IRA holders can pass their accounts on to heirs without ever taking distributions. However, unlike Traditional IRAs, Roth IRA holders must own their account for at least five years before taking qualified distributions.
These tax-related differences aside, there are few other differences between a Roth IRA and Traditional IRA. Account holders can make the same investments, both accounts have to be held at qualified custodians, and both enjoy tax-free (or tax-deferred) growth in their account.
How a Traditional IRA Works
A Traditional IRA is a retirement account that allows account holders to make up to $5,500 in tax-deductible contributions. Once contributions are made, Traditional IRAs grow tax-free. You can’t take money out until you are 59½ and—when you do—it’s taxed as income. Any withdrawals taken before 59½ are subject to a 10 percent penalty.
Within a Traditional IRA, there are all sorts of investments you can make depending on those available through your IRA provider. In addition to tax-deductible contributions, your account grows tax-free until you start taking withdrawals. However, there are both Traditional IRA pros and cons. For example, while Traditional IRA withdrawals can start at 59½, account holders must start taking required minimum distributions at age 70½.
Some investments you can make in a Traditional IRA include:
- Stocks – Shares in specific companies that trade on exchanges
- Bonds – Debt issued by companies or countries
- Mutual Funds – Baskets of stocks and bonds that are professionally managed
- ETFs – Groups of stocks or bonds that are structured like mutual funds but trade like individual stocks
- Target Date Funds – Mutual funds that shift from stocks to bonds as a target retirement date approaches
- Options – The right to buy or sell an underlying stock at a certain price
- Futures – Contracts for oil, gas, gold, or other underlying assets
- Currencies – Foreign exchange for currencies around the world
Traditional and Roth IRA Alternatives for Small Business
There are a number of differences between Roth and Traditional IRAs that make a Traditional more appropriate for some investors or a Roth IRA better for others. However, if an investor is eligible for an employer-sponsored retirement plan, they may not be eligible for an IRA or may be better off participating in an employer plan.
Some Roth vs. Traditional IRA alternatives include:
- Traditional 401(k) – A Traditional 401(k) is a typical, cost-effective retirement plan that’s offered by many businesses. Using a Traditional 401(k), an employee can contribute up to $18,500 per year (plus a $6,000 catch-up contribution if you’re over 50) in addition to any employer matching or profit-sharing contributions.
- Roth 401(k) – A Roth 401(k) is like a Traditional 401(k) except that your contribution limit is reduced by the amount you contribute to a Traditional 401(k) account. Roth 401(k) contributions also aren’t deducted from your taxable income, but still grow tax-free and withdrawals are tax-free during retirement.
- SIMPLE IRA – A SIMPLE IRA is very similar to a Traditional 401(k) with almost none of the administration costs. However, SIMPLE IRAs also have minimum requirements for employer-matching.
- SEP IRA – SEP IRAs have the same high contribution limits as 401(k)s and contributions are tax-deductible. However, in a SEP, employers are required to fund contributions for every employee proportional to contributions the employer puts in their own account (as a percent of annual compensation).
Roth vs. Traditional IRA Frequently Asked Questions (FAQs)
If you still have questions about a Roth IRA vs. Traditional IRA, here are some of the frequently asked questions. If you still don’t see an answer to your question, feel free to join the discussion in the comments below or visit the Fit Small Business Forum and post your question.
Do Roth IRAs Have Income Limits?
In order to contribute to a Roth IRA, an investor is required to meet certain Roth IRA income limits. If your income exceeds certain thresholds, you may not be allowed to contribute up to $5,500 to a Roth IRA, or you may not be eligible to contribute at all.
Is It Better to Invest in a Roth IRA or Roth 401(k)?
If you’re eligible for a Roth 401(k) through your work, it’s much better to contribute to a Roth 401(k) vs. Roth IRA. Roth 401(k) contribution limits are much higher than Roth IRAs and Roth 401(k) eligibility is must less restrictive than Roth IRAs.
Can You Have a Roth IRA and Roth 401(k) at the Same Time?
Yes, if you meet Roth IRA income limits, it is possible to have a Roth 401(k) and Roth IRA at the same time. If you’re eligible for a Roth 401(k) at work and also meet Roth IRA eligibility requirements, you may still be able to contribute to a Roth IRA outside of your employer-sponsored plan.
What Is the 5-Year Rule for Roth IRAs?
Investors who choose to use Roth IRAs aren’t allowed to take qualified distributions from their Roth until five years after they’ve opened their account. Not all of their contributions must stay in their Roth for five years, but they must have their account for at least five years to take distributions without incurring penalties.
Can I Put Traditional IRA RMDs into a Roth IRA?
It’s against IRS rules to reinvest required minimum distributions from a retirement account into another qualified retirement account. However, you may be able to convert all or part of your Traditional IRA into a Roth by doing a Roth conversion, which requires you to follow certain rules and pay taxes on the balance you convert.
Is There an Age Limit for Roth IRA Contributions?
Unlike a Traditional IRA, you can contribute to a Roth IRA after the age of 70½. While you’re allowed to withdraw funds from a Roth IRA starting at 59½ (provided you satisfy the 5-year rule), Roth IRAs aren’t subject to required minimum distributions and there is no age cut-off to contribute.
The biggest difference between Roth and Traditional IRAs is tax treatment. Many investors choose Traditional IRAs because they want tax-deductible contributions, while others use Roth IRAs for tax-free withdrawals during retirement. When deciding on a long-term financial plan, be sure to find a balance of Traditional vs. Roth IRA contributions that’s right for you.