Traditional and Roth individual retirement accounts are tax-advantaged retirement accounts. An individual retirement account (IRA) is one of the best tools for saving for retirement. But you may notice when you're signing up that IRAs come in two different categories: a traditional IRA and a Roth IRA. Both have important tax benefits, but key differences could make one the better choice for you, depending on your financial goals and position.
The main difference between these two IRAs comes down to when your money is taxed: before you contribute or after you withdraw. You contribute to a traditional IRA with pretax money, but you're taxed on your withdrawals. You contribute to a Roth IRA with after-tax money and enjoy tax-free withdrawals. Here’s a closer look at what that means to help you make the right choice for your financial situation.
What’s the Difference Between Traditional and Roth IRAs?
| Traditional IRA | Roth IRA | |
|---|---|---|
| Contributions | Contributions are untaxed, and you can deduct contributions from this year’s taxes | Contributions were already taxed, and you cannot deduct contributions from this year’s taxes |
| Annual contribution limits | $6,500 per year with no income limits; additional $1,000 per year allowed for age 50 or older | Up to $6,500 a year (or $7,500 if you’re age 50 or older), but income limits apply |
| Qualified withdrawals | Taxable, begin at age 59½ | Tax free beginning at age 59½ |
| Required minimum distributions | At around age 70 to 72 (depends on birth year) | No minimum required distribution (RMD) rule |
| Account types and availability | Widely available from most brokerage firms and many other financial companies in the form of investments, savings accounts, and CDs | Widely available from most brokerage firms and many other financial companies as investments, savings accounts, and CDs |
These annual contribution limits go into effect on Jan. 1, 2023. They're $500 more than they were in 2022.
Contributions
Traditional IRAs require pretax contributions. You don’t pay any taxes on that income during the year of your contribution, but taxes are required on withdrawals you take when you retire. Ideally, you'll save on taxes long term due to this strategy, assuming you have lesser earnings and a lower income tax rate during your retirement period.
Contributions are made after tax with a Roth IRA. You pay taxes on that income in the year of your contribution, but qualified withdrawals are tax free. This means that all capital gains aren't taxed. This could be more valuable to you than the traditional IRA pretax deduction benefit if you have a long time ahead of you before retirement.
Annual Contribution Limits
Both types of accounts also have a maximum contribution amount per year, set by the Internal Revenue Service (IRS) annually. The limit for Roth and traditional IRA contributions was $6,000 in 2022, or $7,000 if you were age 50 or older in that calendar year. The limits increase to $6,500 if you’re younger than 50 and $7,500 for those aged 50 or older in 2023.
But some people can't contribute anything to a Roth IRA. These accounts have an income limit for contributions, which keeps some high earners out. If your modified adjusted gross income is over IRS thresholds, the amount you can contribute phases out to zero. For 2022, individuals earning $144,000 and married couples who file jointly and earn $214,000 or more cannot contribute at all to a Roth IRA. These limits increase to $153,000 and $228,000 respectively in 2023.
Note
The contribution limit is the total amount you can contribute to both account types. For example, the total limit is $6,500 for taxpayers younger than 50 for the 2023 tax year. You can put $3,500 in your Roth and $3,000 in your traditional IRA, or $4,000 in your Roth and $2,500 in your traditional IRA, but you can't put $6,500 into each.
Qualified Withdrawals
Qualified withdrawals for both IRA types are available when you reach the age of 59½. Remember that traditional IRA withdrawals are taxed, while Roth IRA withdrawals are tax free. You’re able to withdraw from either of your retirement accounts without paying additional penalties at age 59½. You may have to pay both taxes and a 10% tax penalty if you withdraw from a traditional IRA before that age, making it a costly proposition.
You can withdraw contributions from your Roth at any time without penalty because that money has already been taxed. But more rules apply when you can withdraw the account's earnings. You can only pull earnings out of a Roth after age 59½. Withdrawing earlier could trigger taxes and a 10% penalty.
Note
It’s possible to take penalty-free early distributions, including earnings before age 59½, from both IRA types in certain circ*mstances, such as if you’re making your first home purchase. Speak with a tax professional before withdrawing from your IRA.
Required Minimum Distributions
You must take required minimum distributions (RMDs) at age 72 if you have a traditional IRA. The amount you must withdraw uses a complex formula based on your age and account balance. Check with the IRS or your investment brokerage to ensure you don’t make any mistakes here, because you could wind up with additional taxes or penalties.
A Roth IRA does not require that the account owner take a required minimum distribution. You can leave your contributions and earnings in your Roth IRA until you die.
Account Investments and Availability
Both IRA types allow investors to choose from any supported market investments, including ETFs, mutual funds, stocks, and bonds. You can open either IRA type at a brokerage or bank.
Which Is Right for Me?
Generally, younger investors benefit most from a Roth IRA early in their careers because their investments will grow tax free for decades. Younger investors might also make less money annually at work and therefore fall within the income requirements to make a maximum contribution. These investors can withdraw significant earnings without paying capital gains taxes in retirement.
The pretax benefits of traditional IRAs may prove more valuable for investors who are closer to retirement because they have fewer years for their investments to grow before they stop working. Higher-income earners who make too much to contribute to a Roth can still contribute to a traditional IRA.
Older investors might find the tax-deduction advantages of a traditional IRA appealing. Remember, you can also make catch-up contributions of up to $7,500 after age 50 beginning in 2023 with no income restrictions.
Note
Consider consulting with a trusted financial professional who can guide you through the process if you're not sure which type of account makes the most sense for you.
A Best-of-Both Worlds Option
No law says that you can’t have both a traditional and Roth IRA, although it may be complicated to contribute to both in the same calendar year. Some savers get benefits similar to those of a traditional IRA when investing with an employer-sponsored 401(k) plan or a similar retirement account. They can still use a Roth IRA as well for after-tax benefits.
Combining a 401(k), IRA, and health savings account (HSA) helps you layer on tax savings through multiple investment accounts if you're eligible. No perfect solution exists for everyone, but you can work through your budget, your savings ability, and anticipate your future needs to find the savings method and investment account that make the most sense for your retirement.
The Bottom Line
Investing is critical for most Americans who are looking to maintain the same standard of living during retirement as they enjoyed during their working years. Many investment experts suggest saving at least 15% of your pretax income for retirement, including through individual retirement accounts, 401(k) accounts, and other tax-advantaged accounts.
An IRA could be the perfect fit for you if you’re not yet saving for retirement or don’t have access to an employer-sponsored retirement account.
Frequently Asked Questions (FAQs)
Which is better, a Roth IRA or a traditional IRA?
In general, it may make sense to use a Roth IRA if you think your retirement tax rate will be higher than your rate is now. Your qualified withdrawals will be tax free. And a Roth offers tax-free withdrawals as long as you meet the exceptions’ requirements if you need access to cash before retirement for other uses, such as purchasing a home. But a traditional IRA might make more sense if you think your tax rate will be lower in retirement than it is now, or if you make too much money to qualify for a Roth.
What taxes are involved when withdrawing from a Roth IRA versus a traditional IRA?
You can withdraw your Roth IRA’s contributions and earnings via distribution and not pay taxes when you reach age 59½ because you’ve already paid taxes on that money. When you withdraw contributions or earnings from traditional IRAs, they’re taxable. This is true whether you withdraw before age 59½ or later. Both types of withdrawals may incur an additional 10% penalty if the withdrawals don’t qualify for exceptions.
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Sources
The Balance uses only high-quality sources, including peer-reviewed studies, to support the facts within our articles. Read our editorial process to learn more about how we fact-check and keep our content accurate, reliable, and trustworthy.
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IRS. "Retirement Topics — Required Minimum Distributions (RMDs)."
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