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Retirement

Roth IRA vs Traditional IRA: Key Differences & Similarities

Overview

  • Both the traditional and Roth IRA have contribution limits of $6,000 ($7,000 if age 50+) in 2022 and $6,500 ($7,500 if age 50+) in 2023.
  • With a Roth IRA, you contribute with after-tax dollars. You get no immediate tax savings, but withdrawals in retirement are completely tax-free.
  • With a traditional IRA, you contribute with pre-tax dollars. Contributions are deducted from your taxable income for the year, but withdrawals in retirement get taxed as regular income.
  • With a Roth IRA, you can withdraw your contributions at any time without penalties or fees. For withdrawals on earnings in your account, you must be at least 59½ years old, plus your account must be at least 5 years old.
  • With a traditional IRA, you don't have the option to withdraw contributions, with no penalties or taxes. You have to wait until you're 59½ years old to start taking distributions. A traditional IRA does not have a Five-Year Rule like the Roth IRA.
  • A traditional IRA has required minimum distributions. You must start making withdrawals each year after you turn 72 years old. A Roth IRA has no required minimum distributions and you can keep your money compounding as long as you're alive.
  • You can contribute to both a traditional and Roth IRA at the same time, as long as total contributions do not exceed the yearly contribution limits.

An individual retirement account (IRA) can help self-employed individuals save for their retirement. While you're allowed to have an IRA in addition to a company 401k, it's especially popular for people who don't have access to an employer-sponsored retirement plan.

There are many types of IRAs, but the most common ones are the traditional IRA and Roth IRA. Both are similar types of accounts, but they have some key differences in tax treatments, eligibility, and withdrawals.

Contribution Limits: Same

Annual contribution limits are the same for both the traditional IRA and Roth IRA.

The contribution limit for a traditional IRA and Roth IRA is $6,000 ($7,000 if age 50+) in 2022 and $6,500 ($7,500 if age 50+) in 2023.

Your contributions cannot exceed the amount of income you earned that year. For example, if you only earned $4,000 in 2022, you can only contribute up to $4,000 into a traditional or Roth IRA.

Contribution Deadline: Same

You have until the federal tax filing deadline to make contributions into your account. Typically, that's April 15, of the following year. For 2023, the exact federal tax-filing deadline is Tuesday April 18, 2023 since the 15th falls on a Saturday and the coming Monday is a national holiday.

Tax-Advantages: Different 

The main difference between the two accounts is when they get taxed.

  • With a traditional IRA, you contribute with pre-tax dollars, and your contribution is deducted from your taxable income for the year. However, you’ll have to pay regular incomes taxes when you start taking distributions in retirement.
  • With a Roth IRA, you contribute with after-tax dollars. You pay income taxes on your contributions now, but withdrawals in retirement are completely tax-free.

Put another way, a traditional IRA gives you tax savings now and a Roth IRA gives you tax savings in retirement.

For example, let's say you make $50,000 this year in income and decide to contribute $6,000 into an IRA this year.

  • With a traditional IRA, the $6,000 gets deducted from your income tax. Your new taxable income becomes $44,000. However, you'll owe income taxes when you withdraw from your account in retirement.
  • With a Roth IRA, your taxable income is still $50,000. However, withdrawals from your account in retirement are tax-free.

Age Requirements: Same

Anyone with earned income can start making contributions to a traditional and Roth IRA even if they're not 18 years old. For example, a 10 year old child with a paper route is eligible to contribute to a traditional or Roth IRA.

Eligibility Rules: Different

For both the traditional IRA and Roth IRA, anyone with earned income can contribute to either account. 

However, there are some additional eligibility rules with each account. 

  • You can contribute to a traditional IRA regardless of your income levels, but if you also receive a 401k at work, then your tax deductions could be reduced to zero.
  • With a Roth IRA, you can't contribute at all if your income is too high.

A Roth IRA has income limits

A Roth IRA has an income limit, while a traditional IRA has no income limit. If you make too high of an income, your contribution limit gets reduced or you're not allowed to contribute at all.

Here are the Roth IRA income limits for 2022 and 2023:

2022

  • If your income is $129,000 or less, you can contribute up to the maximum Roth IRA contribution limit of $6,000 ($7,000 if age 50+).
  • If your income is over $129,000 but less than $144,000, your contribution limit gets reduced.
  • If your income is over $144,000, you cannot contribute at all.

2023

  • If your income is $138,000 or less, you can contribute up to the maximum Roth IRA contribution limit of $6,500 ($7,500 if age 50+).
  • If your income is over $138,000 but less than $153,000, your contribution limit gets reduced.
  • If your income is over $153,000, you cannot contribute at all.

One workaround to the Roth IRA income limit is the mega backdoor Roth IRA. Essentially, you can make your contributions to a separate after-tax account, and then immediately rollover the funds into your Roth IRA. A rollover doesn't follow the same Roth IRA income limits or contribution limits.

A traditional IRA has tax-deduction limits based on MAGI

With a Roth IRA, if your income is too high, you can't contribute. With a traditional IRA, it works a little bit differently. If you have a retirement plan at work, your tax deductions can get reduced if your modified adjusted gross income (MAGI) is too high.

2022

  • If your MAGI is $68,000 or less, you get get a tax deduction up to the maximum traditional IRA contribution limit of $6,000 ($7,000 if age 50+).
  • If your MAGI is over $68,000 but less than $78,000, you'll get a partial tax deduction.
  • If your MAGI is over $78,000, you get no tax deduction.

2023

  • If your MAGI is $73,000 or less, you get get a tax deduction up to the maximum traditional IRA contribution limit of $6,500 ($7,500 if age 50+).
  • If your MAGI is over $73,000 but less than $83,000, you'll get a partial tax deduction.
  • If your MAGI is over $83,000, you get no tax deduction.

Remember, this only applies if you also have a day job where you receive a company 401k.

You can calculate your modified adjusted gross income (MAGI) using Worksheet 1-1 in IRS Publication 590-A.

Withdrawal Rules: Different

Withdrawal rules are different for the traditional IRA and Roth IRA.

  • With a traditional IRA, you just need to wait until you reach the age of 59½ before you're allowed to take qualified distributions. You'll also have to pay income tax on your withdrawals since you contributed with pre-tax dollars.
  • With a Roth IRA, you're allowed to withdraw your contributions at any time without fees or penalties. For withdrawals on earnings in your account, you need to wait until you're over the age of 59½, plus your account must be at least 5 years old.

Traditional IRA withdrawal rules

When you can withdraw without penalties: You can start taking qualified distributions from your traditional IRA when you reach the age of 59½.

Taxes on withdrawals: With a traditional IRA, you contributed with pre-tax dollars and received a tax-deduction. Therefore, your withdrawals in retirement will be taxed as regular income.

Penalties for early withdrawals: Early withdrawals will be hit with a 10% fee plus income taxes on the amount withdrawn.

Roth IRA withdrawal rules

When you can withdraw without penalties: With a Roth IRA, you can withdraw your contributions at any time without penalties or fees. This is because you already paid taxes on your contributions.

If your account has any earnings, that portion of your account cannot be withdrawn until you reach the age of 59½ AND you made your first Roth IRA contribution at least 5 years ago. This is called the Five-Year Rule, and it applies only to the Roth IRA and not the traditional IRA. For example, if you open your Roth IRA and make your first contribution when you're 57 years old, you will have to wait until you're 62 in order to withdraw earnings from your Roth IRA without penalties.

Taxes on withdrawals: With a Roth IRA, you don't pay any taxes when you take qualified distributions, since you already paid taxes when you made your contributions.

Penalties for early withdrawals: Withdrawals of contributions have no penalties regardless of your age or account age. Early withdrawals on account earnings will be hit with a 10% fee plus income taxes.

RMD Rules: Different

RMD stands for required minimum distribution. Most retirement plans have RMD rules set by the IRS, which state that participants of a plan must start taking distributions each year once they reach the age of 72.

A traditional IRA has required minimum distributions, while a Roth IRA does not. With both accounts, you're allowed to continue making contributions past the age of 72. However, you must start taking withdrawals from a traditional IRA, whereas you can leave your Roth IRA alone as long as you're alive.

You can view how to calculate your RMD amounts using this RMD table.

Can you contribute to both a traditional IRA and Roth IRA?

Yes, you can have both a traditional IRA and a Roth IRA and contribute to both in the same year. However, your total contributions to both accounts must not be greater than the yearly contribution limit.

For example, let's say you wanted to contribute half your money into a traditional IRA and the other half into a Roth IRA. In 2022, the contribution limit for a traditional and Roth IRA is $6,000 or $7,000 if you're 50 or older. If you're under 50 years old, you could contribute a maximum of $3,000 into a traditional IRA and another $3,000 into a Roth IRA.

Roth IRA pros & cons

Pros

  • Withdrawals in retirement are completely tax-free.
  • You can withdraw your contributions at any time without any penalties or taxes.
  • You have no RMD, which allows you to continue compounding your money tax-free as long as you're alive.

Cons

  • You don't get a tax deduction on contributions. There are no immediate tax benefits when you contribute to a Roth IRA.

Traditional IRA pros & cons

Pros

  • Contributions are tax deductible. You lower your income tax each year you contribute.
  • You get to delay your taxes owed until retirement.

Cons

  • Withdrawals in retirement are taxed as regular income.
  • Contributions are not able to be withdrawn at any time like the Roth IRA.
  • You're required to start taking required minimum distributions (RMD) at the age of 72.

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