Traditional vs. Roth IRAs: Comparing Key Features

Individual retirement accounts (IRAs) are a popular option for retirement savings because almost anyone with an income can open and contribute to an IRA. The two most common types of IRAs for individuals are traditional and Roth IRAs, while several other IRA options exist for small businesses.

Both types of IRAs offer tax advantages and work similarly in many ways. But there are important differences to consider, and it might make sense to contribute to one type over the other at different points in your life.

Understanding IRAs

Traditional and Roth IRAs are both tax-advantaged retirement accounts that help you save for the future. You can open an IRA at various financial institutions and then contribute money within annual IRS limits, similar to depositing money into a bank or brokerage account.

Both types of accounts offer tax benefits designed to encourage saving for retirement. The key difference is when you pay taxes on your contributions and earnings.

Traditional IRAs

A traditional IRA might allow you to contribute pre-tax dollars, meaning you may be able to deduct your contributions from your taxable income. Whether you qualify for this deduction depends on your income and whether you have a workplace retirement plan. This tax break can lower your tax bill today, allowing you to pay down high-interest debt or contribute more toward retirement savings. However, when you eventually withdraw money from your traditional IRA in retirement, you'll have to pay taxes on it as regular income.

Roth IRAs

With a Roth IRA, you contribute after-tax dollars, so you don't get a tax deduction up front. As a result, your taxable income might be higher this year. However, the benefit comes later—your contributions and earnings grow tax-free, and qualified withdrawals are completely tax-free.

Traditional vs. Roth IRA Overview

Here's a high-level look at traditional and Roth IRAs.

Similarities Between Traditional and Roth IRAs

Let's take a closer look at some of the similarities between traditional and Roth IRAs.

Age restrictions

• There's no age requirement or limit for either type of account.
• As long as you have taxable compensation for the year, you can keep contributing—even during retirement.
• You can even open a custodial IRA for your child, and they can contribute to it if they have taxable compensation.

Contribution limits

• The IRS sets a combined annual contribution limit for traditional and Roth IRAs.
• You can contribute to both types in the same year, but the total amount cannot exceed the annual limit.
• You can decide if and how you want to split your contributions.

Income requirements

• Your IRA contribution limit is based on your taxable compensation for the year.
• Taxable compensation includes salary, wages, commissions, self-employment income, taxable alimony, taxable separate maintenance, nontaxable combat pay and certain taxable nontuition fellowship or stipend payments.
• If you're married and file jointly, you may qualify to contribute to your own IRA based on your spouse's taxable compensation.

Contribution deadlines

• You have until the tax filing deadline for the year, not including extensions, to make contributions.
• The tax filing deadline for the current year is usually April 15 of the next year.
• When you contribute, the financial institution may ask if you want it to be for the current or previous calendar year.

Investment options

• You can invest your IRA funds in certificates of deposit (CDs), money market accounts, stocks, bonds, mutual funds, exchange-traded funds (ETFs) or other types of investments.
• You don't have to report earnings or pay taxes when you buy and sell investments in your IRA if you don't withdraw the money from the IRA.
• The options depend on the financial institution where you open the IRA, not the type of IRA.

Excess contributions

• If you contribute more than your contribution limit for the year, you'll have to pay a 6% tax penalty on the excess amount for each year it remains in your account.
• You may be able to limit or avoid the penalty by withdrawing the extra contributions (plus any earnings on it) before your tax deadline, including extensions.

Early withdrawal penalties

• Unless you qualify for an exception, you'll have to pay a 10% tax on money that you withdraw before you turn 59½.
• Exceptions may include withdrawals after a federally declared disaster, for qualifying personal or family emergency expenses, and up to $10,000 for qualified first-time home purchases.
• The tax is in addition to any regular income taxes on the money.

Key Differences Between Traditional and Roth IRAs

Although many of the basics are the same, there are a few important differences between traditional and Roth IRAs.

Tax benefits

• Traditional IRA: Offers an up-front tax deduction on contributions (if eligible) and lets you defer the income taxes on your earnings.
• Roth IRA: Offers tax-free growth and tax-free qualified withdrawals without any up-front deductions.

Income limits

• Traditional IRA: You can contribute regardless of your income, but your deduction may be limited by your income and whether you have access to an employer-sponsored retirement plan.
• Roth IRA: You can't contribute if your modified adjusted gross income (MAGI) is above the IRS threshold for the year based on your filing status.

Required minimum distributions

• Traditional IRA: Once you turn 73, you must start taking annual required minimum distributions (RMDs). The amount depends on the account's balance, your age and whether your spouse is the primary beneficiary of the account.
• Roth IRA: Doesn't have RMDs while the original account owner is alive. However, inherited Roth IRAs are subject to RMD rules.

Withdrawing contributions

• Traditional IRA: The same withdrawal rules and requirements apply to contributions and earnings.
• Roth IRA: You can withdraw the contributions you made to a Roth IRA at any time without paying income tax or additional taxes on the money.

Which IRA Is Right for You?

If you meet the eligibility requirements, you can contribute to a traditional IRA, Roth IRA or both in the same year. Just remember that the total contributions across both accounts cannot exceed the IRS annual limit. Deciding which IRA to prioritize depends on several factors, including your current and future tax situation.

To maximize tax savings, a common rule of thumb is to compare your current tax bracket with your expected tax bracket in retirement.

If you're in a higher tax bracket now, a traditional IRA may be more beneficial because you get an up-front tax deduction, reducing your taxable income today.

If you expect your income—and tax rate—to increase in the future, a Roth IRA may be the better option because your investments grow tax-free, and qualified withdrawals in retirement won't increase your taxable income.

Splitting your savings between traditional and Roth accounts can also be strategic. For example, you may be collecting Social Security and taking RMDs from traditional accounts during retirement. If you only need a little extra money, you can prioritize taxable distributions from the traditional accounts. But if a major expense pops up, you can take money from a Roth IRA without increasing your taxable income.

Think through these potential scenarios and other individual choices that may affect your income and taxes, such as whether you might retire in a state that doesn't have income taxes. If you still have questions, you could also work with a financial advisor to estimate how much you should save and which types of retirement accounts you should use.

READ MORE: 10 Questions to Help Accurately Calculate Your Retirement Numbers