Individual retirement accounts (IRAs) are tax-advantaged long-term savings and investment vehicles intended to help carry you through your retirement years. Some IRAs may be available through your employer, but most are intended for you to set up and contribute to on your own outside of your employer’s benefits. The two most common IRAs are a traditional IRA and Roth IRA. Though both accounts function to help you save for retirement, they have key differences involving tax deductions/timing of tax advantages, eligibility to open and contribute to one, and fund accessibility/withdrawal requirements. Remember, retirement accounts have many differences, but two advantages of IRAs over 401(k)s is your ability to access a greater breadth of investment options and more control over where and how your money is invested and managed.

Both traditional and Roth IRAs offer tax-free investment growth—the main difference lies in when those taxes are paid. Let’s go through each and discuss the similarities and differences between traditional and Roth IRAs.

What Is a Traditional IRA?

As the individual account owner, you open and fund the IRA yourself, with no employer sponsor or matching. There are no income limits to traditional IRA accounts, meaning you can be a high earner and use a traditional IRA for retirement savings. The 2024 contribution limit is $7,000 and $8,000 for those over 50.

Your IRA contributions will generally lower your taxable income in the year you make the contributions. You may be eligible for an income tax deduction on your contributions if you’re not already using an employer-sponsored retirement account and earning less than $74,000. Check your plan to determine if you’re eligible. Your IRA account will grow tax-deferred; when you withdraw funds in retirement, you will pay taxes.

Additionally, you can use an IRA account to roll over 401(k)s from past jobs. There is an early withdrawal penalty if you’re 59.5 or younger (though, there are exceptions to this, including if you use the distribution for qualified expenses or are permanently disabled). Traditional IRAs require withdrawals at age 73 and beyond—even if you don’t need the money.

What is a Roth IRA?

Like traditional IRAs, you open and fund the IRA as the individual account owner, with no employer sponsor or matching. Roth IRA contributions are made with after-tax money, meaning they don’t reduce taxable income or allow for income tax deductions. However, your Roth IRA balance grows tax-free, and your withdrawals in retirement are also tax-free. The 2024 contribution limit is $7,000 and $8,000 for those over 50.

The single most advantageous aspect of a Roth IRA is the tax-free income in retirement. However, Roth IRAs have income limits for making contributions; for 2024, single filers with a modified AGI (MAGI) of $161,000 and married couples filing jointly with a MAGI of $240,000 or more are not eligible to contribute to these accounts. Contributions begin phasing out (are reduced) for single filers at $146,000 and $230,000 for married couples filing jointly.

You are not required to take required minimum distributions on Roth IRAs, making these effective wealth-transfer vehicles for those who don’t need to use their Roth savings in retirement. If a Roth IRA is transferred upon death to beneficiaries, they also enjoy the same tax-free withdrawal benefits as the original owner; they are not required to pay taxes on withdrawals, though they are required to make withdrawals over a certain timeframe.

Another key difference between Roth IRAs compared to traditional IRAs is fund accessibility. You can take distributions equivalent to your Roth contributions penalty- and tax-free for any reason before age 59½.

According to Investopedia, if you want to make withdrawals above what you’ve actually contributed (i.e., on the earnings), “you can avoid taxes and the 10% early withdrawal penalty if you’ve had the Roth IRA for at least five years and at least one of the below circumstances applies to you:

• You are at least 59 ½ years old
• Have a permanent disability
• You die and the money is withdrawn by your beneficiary or estate
• Use the money (up to a $10,000-lifetime maximum) for a first-time home purchase.

If you’ve had the account for less than five years, you can still avoid the 10% early withdrawal penalty if:

• You’re at least 59 ½ years old.
• The withdrawal is due to a disability or certain financial hardships.
• Your estate or beneficiary made the withdrawal after your death.
• You use the money (up to a $10,000-lifetime maximum) for a first-time home purchase, qualified education expenses, or certain medical costs.”

Comparison of Traditional vs. Roth IRAs

Rules	Traditional IRA	Roth IRA
2022 Income Limits	Anyone earning an income can contribute to a traditional IRA	$144,000 MAGI for single filers (phasing out begins at $129,000) $214,000 MAGI for married couples filing jointly (phasing out begins at $204,000)
Age Limits	No age limit	No age limit
2022 Contribution Limits	$6,000 $7,000 if over 50	$6,000 $7,000 if over 50
Tax Treatment on Contributions	Before-tax contributions Tax deduction/reduces taxable income in contribution year but is based on income limits and if you participate in your employer-sponsored retirement plan   Contributions grow tax-deferred	After-tax contributions No tax advantages on contributions   Contributions grow tax-free
Tax Treatment on Distributions	Income taxes required on all withdrawals	Tax-free withdrawals on contributions + earnings in retirement
Withdrawals	Withdrawals before the age of 59½ are subject to ordinary income taxes + 10% early withdrawal penalty, with some qualified exceptions	Withdrawals on contributions are allowed at any time for any reason with no taxes or penalty required   If Roth IRA has been open for five years or you’ve reached age 59½, you can withdraw the earnings tax-free as well
Required Minimum Distributions (RMD)	Required starting at age 72 and for beneficiaries of inherited traditional IRAs	Not applicable for account owner   Beneficiaries of inherited Roth IRAs are required to follow a RMD schedule
Extras	Penalty-free withdrawals may be made for certain qualified education and financial hardship reasons   Account owner can withdraw up to $10,000 to cover first-time homebuyer expenses with no penalty   Taxes will always be owed on withdrawals	Once account is open for five years, account owner can withdraw up to $10,000 of earnings to cover first-time homebuyer expenses with no penalty   May cover qualified educational and financial hardship withdrawals on earnings without penalty before the age of 59½ and five-year waiting period
Reference the IRS’s guide for IRA contribution and deduction limits for a comprehensive look at IRA limits.

Is a Traditional or Roth IRA Right for You?

Which account(s) you set up and fund in pre-retirement have implications on your gross income and tax burdens now and your future taxes in retirement. We always advocate for saving for retirement in every way that makes sense for you. A key retirement planning focus is understanding your current tax situation and goals and future tax implications in retirement. Failing to effectively coordinate your retirement income sources with your expected taxes can leave you with a surprise tax bill. Luckily, a financial planning and/or tax professional can help you map out your tax plan in retirement.

It’s crucial to understand each source of your retirement income and the tax implications associated with each account/source and try to project your future income tax bracket in retirement. While you might not be making money from a job any longer, your taxable income can sometimes remain the same, and you’ll likely have Social Security benefits that you’ll also need to pay taxes on. Generally, if you think you’ll be in a higher tax bracket in retirement than you are in your working years, a Roth IRA can make the most sense since withdrawals are tax-free. In general, Roth accounts are more flexible with regard to accessing the funds and managing your taxes. If you expect to be in a lower tax bracket in retirement, a traditional IRA that reduces your current taxable income might make the most sense.

Essentially, it breaks down to if it makes more sense for you to enjoy future tax-free withdrawals or take advantage of tax benefits today.

Can You Contribute to Both a Traditional and Roth IRA?

Yes! As long as certain requirements are met, some people elect to set up both to hedge their tax burdens now and in the future. Keep in mind that if you have both a Roth IRA and traditional IRA, your combined contribution limit cannot exceed $6,000 for the year ($7,000 if you’re 50 or older).

Can You Convert a Traditional IRA to a Roth IRA?

Yes, as long as you pay income taxes on the converted amount (since no taxes have been paid on it to date with a traditional IRA).

There is also a backdoor Roth conversion available for high earners who want take advantage of a Roth IRA’s benefits but don’t qualify due to income limits. Watch our YouTube video here to learn more.

Should You Max Out Your IRA Contributions?

Again, we advocate for contributing as much as financially possible to retirement accounts for the tax savings now or later—and retirement savings in general.

Banks, credit unions, brokers, and other investment professionals generally offer IRAs with varying fees and incentives, and they can help you set up, fund, and manage your account if desired. No matter where you’re at in life, it’s never too soon to make decisions for your retirement and financial security. Even small contributions now can have a big impact on your financial future.

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This blog expresses the author’s views as of the date indicated, are subject to change without notice, and may not be updated.  The information contained within is believed to be from reliable sources.  However, its accurateness, completeness, and the opinions based thereon by the author are not guaranteed – no responsibility is assumed for omissions or errors.  This blog aims to expose you to ideas and financial vehicles that may help you work towards your financial goals. No promises or guarantees are made that you will accomplish such goals. Past performance is no guarantee of future results, and any expected returns or hypothetical projections may not reflect actual future performance or outcomes. All investments involve risk and may lose money. Nothing in this document should be construed as investment, tax, financial, accounting, or legal advice. Each prospective investor must evaluate and investigate any investments considered or any investment strategies or recommendations described herein (including the risks and merits thereof), seek professional advice for their particular circumstances, and inform themselves about the tax or other consequences of any investments or services considered.  Investment advisory services are offered through Liberty Wealth Management, LLC (“LWM”), DBA Liberty Group, an SEC-registered investment adviser.  For additional information on LWM or its investment professionals, please visit www.adviserinfo.sec.gov  or contact us directly at 411 30^th Street, 2^nd Floor, Oakland, CA  94609, T: 510-658-1880, F: 510-658-1886,  www.libertygroupllc.com. Registration with the U.S. Securities and Exchange Commission or any state securities authority does not imply a certain level of skill or training.

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References

Appleby, Denise. (March 25, 2022). Roth IRA vs. Traditional IRA: What’s the Difference? Investopedia. https://www.investopedia.com/retirement/roth-vs-traditional-ira-which-is-right-for-you/

LaPonsie, Maryalene. (March 18, 2020). Deciding Between a Roth vs. Traditional IRA. U.S. News. https://money.usnews.com/money/retirement/articles/deciding-between-a-roth-vs-traditional-ira

Marquit, Miranda, & Schmidt, John. (February 19, 2022). Traditional IRA vs. Roth IRA: Which Do You Need. Forbes. https://www.forbes.com/advisor/retirement/traditional-ira-vs-roth-ira/

Yochim, Dayana, & Coombes, Andrea. (November 29, 2021). Roth IRA vs. Traditional IRA. Nerdwallet. https://www.nerdwallet.com/article/investing/roth-or-traditional-ira-account