Traditional IRA vs. Roth IRA: Which Is Best?

vorDa / iStock.com

A Roth IRA and traditional IRA both have the same goal – to help you save for retirement and ensure you don’t spend your golden years struggling to make ends meet. The key difference between a Roth and a traditional IRA is when taxes are applied to your investment. Both offer tax advantages you can’t get in a regular, non-retirement investment account. Both can help you reach your long-term savings goals. But there are fundamental tax differences between the two types of accounts.

Depending on your current and future tax situations, one account might give you an edge. Understanding the ins and outs of both types of accounts can help you decide which one is the better option to maximize your long-term savings.

Roth IRAs vs. Traditional IRAs

In many ways, traditional and Roth IRAs are two sides of the same coin. Both provide tax benefits for retirement savings, but they do so in opposite ways.

Here’s a breakdown of the Roth vs. traditional IRA comparison, examining similarities and differences between the two types of accounts.

Retire Comfortably

Traditional IRAs

A traditional IRA is a tax-deferred retirement account that offers income tax deductions on certain contributions.

A traditional IRA is best suited for those who expect to be in the same or lower tax bracket when they start taking withdrawals. It’s also an appropriate vehicle if you want the benefit of a current tax deduction rather than waiting until retirement to enjoy the primary tax benefit.

Retire Comfortably

Roth IRAs

A Roth IRA is a tax-deferred retirement investment account that allows for tax-free withdrawals on qualified distributions.

The Roth IRA is best if you expect to be in a higher tax bracket when you start taking withdrawals because you won’t be taxed on the distributions.

Key Differences

Traditional and Roth IRAs have numerous important differences you will want to be aware of before making a choice. Here’s a rundown of some key differences between the two.

Retire Comfortably
Feature Traditional IRA Roth IRA
Eligibility Anyone with taxable compensation Anyone who has taxable compensation and a modified adjusted gross income below certain amounts
Tax breaks Qualifying contributions are deductible Contributions are not deductible
Annual income limit for making contributions None -Married filing jointly: $214,000

-Married filing separately: $10,000

-Single, head of household or married filing separately living apart: $144,000

Distribution Mandatory distributions start after you turn 72 No mandatory distributions
Withdrawals Withdrawals are taxable Qualified distributions are not taxed

Early Withdrawals

You can withdraw contributions to your Roth IRA anytime you want, free of taxes and penalties. But if you want to withdraw earnings tax-free, you have to be at least 59 ½ years old and also have owned the Roth for at least five years. The five-year holding period begins on January 1 of the year you opened the account.

With traditional IRAs, in most cases, you have to wait until you are 59 ½ years old to avoid a 10% early withdrawal penalty. There are some exceptions, though. You are usually not penalized for an early withdrawal under these conditions:

Retire Comfortably

You might be able to avoid the early withdrawal penalty if you use the IRA distribution to pay for health insurance, higher education expenses, or to buy, build or rebuild a home for yourself or certain family members. Conditions apply to these exceptions, so consult with your tax advisor to make sure you meet them.

Good To Know

In 2021 the IRS issued new life expectancy tables you’ll need to use to calculate required minimum distributions (RMDs) starting in 2022. You’ll notice slightly longer life expectancies than before, meaning RMDs are a little bit lower under the new 2022 tables than under the old ones. To find your 2022 RMD, look up your current age in the IRS’s new tables for 2022.

Traditional IRA vs. Roth IRA: Which Is Better?

When choosing between a traditional IRA and a Roth IRA, there are many factors to consider. Here are a few of them.

Your Tax Bracket

A Roth IRA is preferable if you anticipate being in a higher tax bracket after you retire than while you are working. Your net after-tax income will be higher if you’re taking withdrawals at a time when you’re in a high tax bracket.

Retire Comfortably

For example, say you’re in the 15% tax bracket while working, but anticipate jumping up to the 22% bracket after you retire. If you contributed $1,000 to a traditional IRA while working, you’d get a $150 tax break. But you’d pay $220 in tax on that contribution when you withdraw it after retirement.

With a Roth IRA, the scenario plays out in reverse. You won’t get to save the $150 in taxes on your contribution — but you also won’t pay the $220 in tax on your withdrawal.

Your Age

A Roth IRA is usually preferred over a traditional IRA if you are a younger investor. If you start while you are young, the earnings in your Roth are likely to far exceed your contributions by the time you retire.

Although you missed out on the tax deductions you would have received by contributing to a traditional IRA, the tax-free treatment of your distributions should outweigh that benefit because your distributions will represent a much larger slice of your retirement pie.

Other Retirement Accounts

You might prefer a Roth IRA if your retirement will already be funded by other sources, such as a 401(k). You can continue to contribute indefinitely without taking mandatory distribution requirements. With a traditional IRA, you are forced to withdraw from your account even if you don’t need the money yet.

Your Income: IRA vs. Roth IRA Income Limits

Sometimes you have no choice between a traditional IRA and a Roth IRA. If your income is too high to contribute to a Roth IRA, then a traditional IRA is obviously the only option.

Final Take

The biggest selling point of a traditional IRA is the advantage of tax-deferred growth. It’s a good option if you are on a tight budget and don’t want to be taxed on your contributions. But that doesn’t mean it’s the best investment vehicle for everyone.

Roth IRAs offer more flexibility, which is important considering that the tax landscape and your finances might change. You don’t know today what tax bracket you’ll be in during retirement. So think twice before giving up the features of a Roth IRA just because you don’t want to pay taxes now. Above all, what matters right now is saving for retirement.

Vance Cariaga contributed to the reporting for this article. 

Information is accurate as of Feb. 28, 2022.