IRA

Key Differences Between Roth IRA vs. Traditional IRA

Let’s talk about your future.

Are you saving enough for retirement?

Or do you need some shocking retirement statistics to motivate you?

But since you’re here researching Individual Retirement Accounts (IRAs), chances are you’re on the right path! Because both Roth IRAs and Traditional IRAs will allow you to save money for retirement. So, how exactly do they differ?

One of the key differences between a Roth IRA versus a Traditional IRA is that one allows you to enjoy tax-free withdrawals in the future, while the other allows you to take advantage of tax benefits today. Overall, however, they both provide generous tax breaks in their own way.

But, which does which?

Read on to find out, as we highlight some of the main similarities and differences between the two.

Note: Though pulled from the horses mouth (Internal Revenue Service), these are still general rules and figures. You may wish to consult a tax advisor about your particular situation to confirm if the information ahead equally applies to you.

Roth IRA vs. Traditional IRA Eligibility

Are there differing eligibility requirements when it comes to individual retirement accounts? Let’s find out.

Is there an age limit to investing in a Roth or Traditional IRA?

(Source: IRS I)

There are no age limits on contributions to either type. But there are age limits when it comes to required mandatory disbursements, which we will address in more detail below.

How does my income affect how much I can contribute?

(Source: IRS II)

For both the Roth IRA and Traditional IRA:

  • You can’t exceed the amount of income you earned that year.
  • You can’t exceed the IRS imposed limits (see limits down below)

For the Roth IRA:

  • The amount you can contribute could be reduced or even eliminated based on your MAGI (Modified Adjusted Gross Income). Generally speaking this is your Adjusted Gross calculated without certain deductions and exclusions.

Can minors or nonworking spouses contribute to an IRA?

(Source: IRS II)

Both minors and nonworking spouses may be able to contribute to either plan, however you must check the special income rules. Which essentially state that a nonworking spouse may still contribute to what is termed a “spousal IRA”, as long as they file a joint-tax return with the working spouse.

However, the total amount contributed by both spouse cannot exceed the lesser of these two:

  • income earned by the working spouse,
  • the contribution limits set by the IRS (see below)

Spousal IRAs are not different types of IRAs. They’re just a means by which nonworking spouses can access the tax favors and benefits that IRAs offer, when saving for retirement in a tax-efficient way.

Minors may also be able to contribute to an IRA. However, the income limits are based on the minor’s income and not the parents’.

Roth IRA vs. Traditional IRA Contribution Rules

Next, let’s find out how the Roth and Traditional IRAs differ when it comes to contributions.

What are the contribution limits for Roth and Traditional IRAs?

(Source: IRS I)

The below limits could end up being lower based on your earned income. They may also seem insignificant at first glance, but over time they can add up (compound) to a significant amount of money!

The following are contribution limits for the 2021 tax year:

Roth IRA contributions:

  • Under the age of 50? You can contribute up to $6,000.
  • If you’re aged 50 or over, you can contribute up to $7,000.

Traditional IRA contributions:

  • Under the age of 50? You can contribute up to $6,000.
  • If you’re aged 50 or over, you can contribute up to $7,000.

Note: You can never contribute more than you’ve earned for the year.

Additionally, for Roth IRAs your modified adjusted gross income (MAGI) may effect whether you can contribute your max amount. And, if your income is too high, whether you are eligible to contribute to a Roth IRA at all. The amount you can contribute can be reduced or “phased out” as your MAGI income edges closer to the upper limits, see below.

Roth IRA phase-out ranges:

Filing Status2020 Income Range2021 Income Range
Single$124,000 – $139,000$125,000 – $140,000
Married, filing jointly$196,000 – $206,000$198,000 – $208,000
Married, filing separately*$0 – $10,000$0 – $10,000

Note: The (asterisk) * in the table above denotes that if you and your spouse didn’t live together during the taxable year, you’ll be viewed as “single” for Roth IRA contribution purposes.

Can I claim my contribution as a deduction on my tax return?

(Source: IRS I)

To deduct or not to deduct? That is the question.

  • Roth IRA: No, Roth IRA contributions are never tax-deductible.
  • Traditional IRA: You may be able to deduct some or all of your contributions. But the contribution amount could be reduced or removed altogether depending on:
    • your modified adjusted gross income,
    • and whether you (or your spouse) are covered by an employer retirement plan.

Note: The limits on deduction amounts don’t affect the amount you can contribute. But, you can never claim a tax-deduction for more than the amount you contributed to an IRA in a given year.

What’s the deadline for making IRA contributions in a given year?

(Source: IRS I)

The deadline is typically April 15th of the following year.

Meaning if you’re contributing for 2021, you have until April 15th, 2022 to do so.

Which is in-line with the historical federal income tax filing deadline. Unless the government extends the deadline, as they did in 2021, when they pushed it out to May 17th, 2021. And the IRS further extended the deadline for certain states (OK, TX, LO) to June 15th, 2021.

How much money do I need to open an IRA account?

The IRS doesn’t require a minimum amount to open an IRA account. But some providers do. Thus, if your goal is to open one up on a budget, look for providers with low or $0 account minimums.

Furthermore, though there are many low account minimum investments out there, some mutual funds require a minimum $1,000 investment, so be sure to factor that in as you’re choosing where to invest the money.

Overall, opening an IRA is actually pretty easy. You can do so online in a few simple steps, and it goes even quicker once you’ve identified the right provider for your financial needs.

Related: 30+ Mutual Funds Statistics & Trends You Should Know

Roth IRA vs. Traditional IRA Withdrawal Rules

Next, we cover how the Roth and Traditional IRAs differ when it comes to pulling money out.

Will I pay taxes on withdrawals from my Roth or Traditional IRA?

(Source: IRS II)

Roth IRA withdrawals

What will happen if you request a withdrawal from your Roth IRA?

Contributions: No taxes or penalties when withdrawing your Roth IRA contributions.

Earnings: This figure basically means if you withdraw more than you’ve contributed in total.

  • Under the age of 59 1/2: Withdrawals are subject to both a tax and a penalty on the earnings portion. Unless your account is at least 5 years old and you qualify for an exception.
  • Aged 59 1/2 or older: This is where the 5-year holding period comes into play.
    • + account age under 5 years: Subject to 10% federal penalty tax.
    • + account age over 5 years: Not subject to taxes on withdrawals.
    Note: The 5-year holding period for Roth IRAs starts on the earlier of:
    • date you first contributed directly to your Roth IRA account,
    • the date you roller over a Roth 401(k) or a Roth 403(b) to your Roth IRA,
    • or the date you converted from a Traditional IRA to the Roth IRA. (If you’ve converted multiple accounts, you must keep track of the 5-year period for each separately).

Traditional IRA withdrawals

What will happen if you request a withdrawal from your Traditional IRA?

Contributions & Earnings: This means all earnings and any originally tax-deducted contributions.

  • Under the age of 59 1/2: Withdrawals are subject to a 10% federal penalty tax plus regular income tax on the taxable amount of your withdrawal. And your taxable amount is generally the entire withdrawal, unless you’re qualified for an exception.
  • Aged 59 1/2 or older: You’ll be paying ordinary income tax on all earnings you withdraw and on any contributions you originally deducted from your taxes over time.

So, withdrawing early can mean paying a minimum 10% penalty, unless you have an exception.

Is there a penalty for withdrawals taken before age 59½?

(Source: IRS I)

Roth IRA: No penalty on withdrawing contributions, but subject to a 10% federal tax penalty on the amount of earnings you withdraw. Unless you meet a qualifying exception below.

Traditional IRA: There is a 10% federal penalty tax on withdrawals of both earnings and contributions. Unless, as with a Roth, you meet a qualifying exception outlined below.

Qualifying Exceptions for Both Roth IRA & Traditional IRAs

  • Roth IRAs: Firstly, contribution withdrawals are always tax-free. But if you’re under the age of 59 1/2, and you’ve had your Roth IRA for at least 5 years, your earnings withdrawals may not be subject to the 10% federal tax penalty, if at least one of the qualifying exception below applies.
  • Traditional IRAs: Withdrawals of both earnings and contributions from a Traditional IRA may not be subject to the 10% federal tax penalty if you’re under the age of 59 1/2 and if they occur because one of the qualifying exceptions below applies.
  • Exception that apply to both Roth and Traditional IRA’s taxable amounts:
    • Owner of the IRA is totally and permanently disabled.
    • IRA owner is using the withdrawal to buy a home for the first-time ($10,000 lifetime limit).
    • Owner of IRA has died and the withdrawal is made to a beneficiary or Roth IRA owner’s estate.
    • Withdrawal is made to a reservist who was ordered or called to active duty:
      • after September 11, 2001
      • for more than 179 days.
    • Post-secondary education expenses.
    • Certain non-reimbursed medical expenses.
    • An IRS levy on the IRA.
    • Substantially equal periodic payments taken under IRS guidelines.
    • Health insurance premiums (after you’ve received at least 12 consecutive weeks of unemployment compensation).
    • The adoption or birth of a child:
      • up to $5,000 per child,
      • distributed within 1 year of birth or adoption.

Please speak with your financial advisor and/or tax advisor for your particular situation.

Will I have to take required minimum distributions (RMDs)?

(Source: IRS II)

Roth IRA

No required minimum distributions for the account owner. But beneficiaries of the Roth IRA account are subject to the RMD rules. So the RMDs are only excluded during your lifetime.

Traditional IRA

Once you turn 72 years old (or age 70½ if you attained age 70½ before 2020), distributions are mandatory and must be withdrawn by December 31 of each year.

Also, account beneficiaries are subject to the required minimum distribution rules as well. If you withdraw less than the required minimum, you may end up owing a 50% penalty tax on the difference between the amount you took out and the required amount you were supposed to.

Note on the numbers used in the article: In an effort to present accurate data, the figures in this article were aggregated from government sources, who keep their numbers up-to-date.

Differences Between Roth and Traditional IRA Infographic

Key-Differences-Between-Roth-IRA-vs-Traditional-IRA

Parting Words

The key difference between Roth and traditional IRAs is in the timing of their tax advantages.

  • Traditional IRAs: Deduct contributions now and pay taxes later on when you withdraw.
  • Roth IRA: Pay taxes on contributions now and get tax-free withdrawals later.

So for most people, especially high income earners, the incentive to choose a Traditional IRA over a Roth is for that upfront tax-break. You stash away the $6,000 ($7,000 if you’re over 50 and over), and you reduce the amount of income you get taxed on that year.

But keep in mind that you’re just deferring that tax burden and not skipping out on it altogether. Which is why some people opt for the Roth IRA and choose to get the tax liability out of the way ahead of time, allowing them to withdraw their contributions tax-free in retirement.

What to read next: 20 Dividend Investing Facts to Know Before You Invest


Sources

IRS I: Traditional and Roth IRAs | IRS II: Publication 590-A (2020)

Finance grad turned digital entrepreneur. I've been investing in the stock market and real estate since 2010, yet I've still so much to learn! My goal is to speak hard truths when it comes to making, growing, and preserving your money on the often arduous entrepreneurial journey.

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