Traditional IRA vs. Roth IRA: 4 Critical Differences

Are you considering opening an Individual Retirement Account (IRA)? If so, you may be wondering which type of IRA is right for you – and you’re not alone.

Updated 9/1/2023

At Addition Financial, one of the most frequent questions we hear from people about our retirement plans is about the differences of a Traditional IRA vs. Roth IRA. We understand it can be confusing, which is why we’ve put together this guide explaining the four critical differences between a Traditional IRA and a Roth IRA.

#1: Income Limits

The first key difference between a Traditional IRA and a Roth IRA is the income thresholds that determine whether you’re eligible to contribute.

For a Traditional IRA, the determination is simple. Anybody at any age who has earned income can contribute. The only real requirement is that your income must match or exceed the amount of your contribution.

Roth IRAs have income-eligibility restrictions as follows:

  • Single tax filers must have a modified adjusted gross income of less than $138,000
  • Married couples filing jointly must have a modified AGI of less than $218,000

There are levels at which Roth IRA contributions phase out. For single filers, the level is $153,000, and for married couples filing jointly, it’s $228,000. You can find more information about income limitations on the IRS website, here.

#2: Tax Incentives

Traditional and Roth IRAs both provide tax breaks, but there are differences in when you can claim them. That’s because contributions to Traditional IRAs are made from your pre-tax income, while contributions to Roth IRAs come from your net income.

Here’s what that means in terms of your tax burden:

  • Your contributions to a traditional IRA are tax-deductible on both your state and federal tax returns in the year you make the contribution. When you make withdrawals in retirement, the withdrawals will be taxed at ordinary income tax rates.
  • Your contributions to a Roth IRA are not eligible for a deduction on your state or federal tax returns when you make the contribution. However, when you withdraw your contributions or earnings in retirement, they are usually tax-free.

You may choose a Roth IRA if you think it’s likely that your tax rate is lower now than it will be in retirement. Either way, the earnings on your contributions remain tax free while they are in your account.

Keep in mind that reducing your pre-tax income with a Traditional IRA may help you qualify for additional tax credits.

#3: Withdrawal Requirements

One of the biggest differences between a Traditional IRA and a Roth IRA is the timing of your withdrawals from your account.

If you opt for a Traditional IRA, you’ll be required to begin taking withdrawals when you reach the age of 73. There are no exceptions to this rule. For that reason, it’s more common to rely on a Traditional IRA for regular income in retirement than a Roth IRA, although both can be useful.

By contrast, there are no mandatory withdrawals with a Roth IRA. You can leave the money in your account and allow it to grow without being required to withdraw money at any time. Sometimes, people who want to leave money to their children and grandchildren choose a Roth IRA for this reason.

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#4: Early Withdrawals

Both Traditional and Roth IRAs have rules about early withdrawals. In this case, “early” means before the account holder has reached the age of 59 ½.

With a Traditional IRA, money withdrawn before the age of 59 ½ may be subject to penalties unless it meets certain requirements. They include:

  • Up to $10,000 for qualified first-time homebuyer expenses
  • Up to $10,000 for qualified higher education expenses
  • Withdrawals for hardship
  • Withdrawals for other qualified expenses

While you may be able to avoid the 10% penalty, you may be required to pay taxes on your withdrawals.

With a Roth IRA, you can withdraw your contributions before you reach the age of 59 ½ without paying a penalty. You can also withdraw earnings without paying a penalty, provided you:

  • Have had the account for at least five years
  • Have a qualified expense

If you plan to buy a home, you’ll want to keep these exceptions in mind before you choose an IRA.

What Traditional and Roth IRAs Have in Common

Despite their differences, Traditional and Roth IRAs have some things in common. For example:

  • Both have annual contribution limits of $6,500 for people under the age of 50
  • Both have increased contribution limits of $7,500 for people over the age of 50
  • Both can provide necessary funds for first-time homebuyers or other qualified exceptions

The type of account you choose is dependent on your income and how you think the account will impact your taxes.

Both Traditional and Roth IRAs can provide tax benefits and retirement income. To learn more about Addition Financial's IRAs or to open an account, click here now.

The content provided here is not legal, tax, accounting, financial or investment advice. Please consult with legal, tax, accounting, financial or investment professionals based on your specific needs or questions you may have. We do not make any guarantees as to accuracy or completeness of this information, do not support any third-party companies, products, or services described here, and take no liability or legal obligations for your use of this information.