What's the difference between traditional and Roth IRAs?

Why It Matters:

  • Traditional and Roth IRAs are two very important retirement vehicles.
  • While both offer tax advantages, how and when those tax breaks come differs.
  • Determining which option best suits your needs may depend on a number of factors, including income and tax filing status.

Ryan Johnson tkc.profilePicture Written by: Ryan Johnson | Transamerica
Feb. 14, 2018

5 Min readClock Icon

By now, you’ve likely heard traditional IRAs and Roth IRAs are both important retirement vehicles. If you’re not already contributing to either type of account, you may be wondering which one is right for you. As with many financial decisions, the answer is: It depends.

No surprise, which type of account might best fit your needs depends on a number of considerations. And, as you’ll learn, a mix of both may be an option. Before looking at deciding factors, it’s helpful to define the key differences between both account types.

Tax Advantages: Traditional IRA vs. Roth IRA

While both accounts offer tax advantages, the key difference is how and when those tax breaks come. Contributions to a traditional IRA may be income tax deductible, and proceeds in the account grow tax-deferred. You’ll pay the taxes upon distribution (when you start taking money out).

Qualifying contributions are tax deductible for the year they are made. By age 70 ½, you’ll face required minimum distributions (RMDs). And, by that age, you won’t be able to make additional contributions.

With a Roth IRA, contributions are made after tax. That means no income-tax deduction is provided when making contributions. However, contributions in the account grow and are distributed tax free when certain requirements are met. When you reach 59 ½ — and if your account is at least five years old — you’re eligible for income tax-free withdrawals. Additionally, there are no RMDs.

Contribution Limits

The contribution limits for traditional Roth IRAs remained unchanged in 2018. If you’re under age 50, you can contribute up to $5,500 and up to $6,500 if you’re over age 50 (or turn age 50 during the calendar year the contribution is for). Keep in mind, these limits are shared between traditional and Roth IRAs, so you can’t contribute more than the maximum per year to all of your IRAs.

Deductibility

While a traditional IRA allows you to deduct contributions in the year they are made, there are requirements based on factors like income, tax filing status, and access to employer-offered retirement plans.

If you (and your spouse) are not covered by a retirement plan at work, contributions are tax deductible regardless of income. Or, if you or your spouse do participate in a plan but make less than $63,000 annually (individual) or less than $101,000 (filing jointly) in 2018, contributions are still deductible. You can get a partial deduction for your contributions if you are an unmarried individual making less than $73,000 or a married couple making less than $121,000.Tax deductibility is reduced or phased out above those income levels, so it’s worth considering as you make your decision. As noted above, contributions to a Roth IRA are never tax deductible. The Motley Fool offers these comparisons to better determine your situation.

Eligibility

Your eligibility to contribute to a Roth IRA is dependent on your filing status and modified adjusted gross income (MAGI). If you’re filing status is single and your MAGI is $120,000 or less, you’re fully eligible in 2018. For married couples filing jointly, you’re fully eligible if your MAGI is $189,000 or less.

What’s your best option?

If your income level precludes you from participating in a Roth IRA, then you’ll obviously want to look at a traditional IRA. But assuming you qualify for both types of accounts, you may want to decide based on the timing of the aforementioned tax breaks. As NerdWallet points out, “A Roth IRA is best if you believe your tax rate will be higher at retirement than it is right now. A traditional IRA is best if you believe your tax rate will be lower at retirement.”

Or to put it another way, you want to pay the taxes when your effective tax rate is lowest – whether that’s now or at retirement.

Of course, if retirement is still many years away, it can be hard to predict what effective tax rate you’ll find yourself in. CNN Money notes, “Another rule of thumb is to keep your retirement savings tax diversified, meaning you have accounts that will be both taxable and tax-free when you cash out in retirement.”

If you already participate in a tax-deferred 401(k) plan through your employer, you may want to add a Roth IRA account to your portfolio if you’re eligible. You’re also allowed to have both a traditional and a Roth IRA to diversify your tax exposure, but remember the contribution limits mentioned above.

For a more detailed comparison of the two types of accounts — and to further help determine which option fits you — the Transamerica Advanced Markets Team created this chart.

To better understand whether a traditional or Roth IRA is right for you, speak with a financial professional.

If you have experience opening an IRA of any kind, join the conversation and share your thoughts with our community.

Things to Consider

  • Contributions to a traditional IRA may be tax deductible, with taxes imposed at the time of distribution.
  • Alternatively, contributions to a Roth IRA are made after tax, so proceeds in the account grow and are distributed tax free when certain requirements are met.
  • If you anticipate a higher effective tax rate at retirement, a Roth IRA might make more sense. If you think you’ll be at a lower rate, then a traditional IRA could be your best choice.
  • Consider diversifying your retirement savings so that you have both tax-deferred and tax-free vehicles.

Neither Transamerica nor its agents or representatives may provide tax, investment or legal advice. Anyone to whom this material is promoted, marketed, or recommended should consult with and rely on their own independent tax and legal advisors and financial professional regarding their particular situation and the concepts presented herein.

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