Roth IRA vs. Traditional IRA: What's the Difference?

The main difference between a Roth IRA and a traditional IRA is when you pay income tax. With a traditional IRA, contributions may be tax-deductible now, and you pay tax when you withdraw money in retirement. With a Roth IRA, you contribute money you have already paid tax on, and qualified withdrawals in retirement are generally tax-free. Which one suits you often comes down to whether you expect your tax rate to be higher now or later, along with income limits and how much flexibility you want.

What an IRA is

An individual retirement account, or IRA, is a tax-advantaged account you open yourself, separate from any workplace plan. Inside the account, you can usually choose investments such as funds, stocks, bonds or cash. The tax benefits are what make IRAs different from a regular investment account.

Both types share an annual contribution limit, set by the IRS and adjusted from time to time, with a higher limit for people over a certain age. The limit applies to your combined contributions across all your IRAs, not to each one separately. You generally need earned income to contribute.

How a traditional IRA works

Tax treatment

Contributions may be tax-deductible, which lowers your taxable income for the year. Your investments grow tax-deferred, meaning you do not pay tax on gains while they stay in the account. When you withdraw money in retirement, withdrawals are taxed as ordinary income.

Deductibility rules

Anyone with earned income can generally contribute to a traditional IRA, but whether the contribution is deductible can depend on your income and whether you or your spouse are covered by a workplace retirement plan.

Withdrawals

Withdrawals before a certain age are generally subject to income tax plus an early withdrawal penalty, though there are exceptions for specific situations. Traditional IRAs also have required minimum distributions, meaning you must start taking money out after reaching a set age.

How a Roth IRA works

Tax treatment

Contributions are made with money you have already paid tax on, so there is no deduction now. Your investments grow tax-free, and qualified withdrawals in retirement are generally tax-free as well.

Income limits

Eligibility to contribute directly to a Roth IRA phases out above certain income levels, which depend on your tax filing status. Some higher earners use other strategies to fund a Roth, but these have their own rules and are worth reviewing with a tax professional.

Withdrawals

You can generally withdraw your original contributions at any time without tax or penalty, because you have already paid tax on them. Earnings are a different story: to withdraw them tax-free, you typically need to meet both an age requirement and a minimum holding period. Roth IRAs do not have required minimum distributions for the original owner.

Side-by-side comparison

Traditional IRA:

• Possible tax deduction now.
• Tax-deferred growth.
• Withdrawals taxed as income in retirement.
• No income limit to contribute, but deductibility may be limited.
• Required minimum distributions apply.

Roth IRA:

• No deduction now.
• Tax-free growth.
• Qualified withdrawals generally tax-free.
• Income limits on direct contributions.
• Contributions can be withdrawn anytime; no required distributions for the original owner.

Questions to help you choose

Do you expect your tax rate to rise or fall?

If you think your tax rate is lower now than it will be in retirement, paying tax now through a Roth may be appealing. If you are in a high bracket now and expect a lower one later, the upfront deduction of a traditional IRA may be more valuable. Nobody knows future tax rates for certain, so this is an estimate rather than a calculation.

Are you early in your career?

Many people early in their careers are in lower tax brackets and have decades for tax-free growth, which is one reason Roth accounts are often discussed for younger savers.

Do you want flexibility?

The ability to withdraw Roth contributions without penalty can provide some flexibility, though raiding retirement savings early has long-term costs.

Do you have a workplace plan?

If you have a workplace retirement plan, your traditional IRA deduction may be limited, which can tilt the decision toward a Roth if you are eligible.

Do you want to diversify your tax exposure?

Some people contribute to both types over their working life, so that in retirement they have a mix of taxable and tax-free money to draw from. This can provide options when tax laws or personal circumstances change.

Can you have both?

Yes. You can generally contribute to both a Roth and a traditional IRA in the same year, as long as your total contributions stay within the annual limit and you meet eligibility rules for each.

Converting a traditional IRA to a Roth

A Roth conversion moves money from a traditional IRA to a Roth IRA. You typically pay income tax on the amount converted in the year you convert. People sometimes consider conversions in years when their income is unusually low. Conversions have rules and tax consequences, so it is wise to work through them with a tax professional.

Common mistakes to avoid

• Contributing over the limit, which can lead to penalties if not corrected.
• Ignoring income limits for Roth contributions.
• Leaving contributions in cash without choosing investments, if that is not your intention.
• Withdrawing earnings early without understanding the taxes and penalties.
• Forgetting the deadline, which is usually around the tax-filing date for the prior year.

The bottom line

Roth and traditional IRAs both help you save for retirement with tax advantages; the difference is whether you get the tax break now or later. A traditional IRA may lower your taxes today, while a Roth can provide tax-free income in retirement and more flexibility with contributions. Because the rules on income limits, deductions and withdrawals are detailed and can change, consider checking current IRS guidance or speaking with a licensed tax or financial professional before deciding.