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.
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:
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.
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:
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.
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.
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:
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:
If you plan to buy a home, you’ll want to keep these exceptions in mind before you choose an IRA.
Despite their differences, Traditional and Roth IRAs have some things in common. For example:
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.