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Traditional vs. Roth IRA: Compare and Learn the Differences

Nov 09, 2020 4 min read Ira Hellman

Key takeaways

  • Want your tax break today? Consider traditional
  • Is patience your virtue? Think Roth
  • College costs ahead? Compare a Roth with 529 savings plans

 

An individual retirement account (IRA) can be a sweet way to help with long-term savings goals. Not only can you invest your money in, well, almost any asset class. You also can get a tasty tax break if you qualify.

 

 

These days IRAs come in two basic flavors: traditional and Roth. Both kinds of accounts can grow (and compound) tax deferred. But that’s where they part company.  

 

How does a traditional IRA work?

A traditional IRA typically cuts your taxes upfront (you can deduct contributions when you file your annual 1040).

 

How does a Roth IRA work?

A Roth IRA differs from a traditional IRA in that it pays off down the road (you may withdraw money tax free at least five tax years after your first deposit).

For both traditional and Roth IRAs, the rules diverge on when you must start withdrawals.

 

  Transcript Opens in new window

 

Differences between Roth and Traditional IRAs

Comparison of Roth IRA and Traditional IRA
 Headlines of Roth IRA and Traditional IRA Roth IRA Traditional IRA
Contribution limits (2021)
  • $6,000 ($7,000 if you’ll be age 50+ by Dec. 31)
  • $6,000 ($7,000 if you’ll be age 50+ by Dec. 31)
Eligibility (2021)
  • Single tax filers with modified adjusted gross income (MAGI) below $139,000 (eligibility starts to phase out at $124,000); joint filers with MAGI below $206,000 (phase-out starts at $196,000)
  • Anyone with earned income can contribute, but tax deductibility is based on income limits and whether you participate in an employer retirement plan
Taxes
  • Contributions are after tax
  • Withdrawals (including any earnings) are tax free after five tax years
  • Accounts accept rollovers from Roth IRAs, 401(k)s, 403(b)s, 457s
  • Contributions are deductible for the tax year in which you make them.
  • Contributions lower your AGI (and potential taxes)
  • Withdrawals are taxable as regular income
  • Accounts accept rollovers from traditional IRAs, 401(k)s, 403(b)s, 457
Withdrawals
  • Contributions can be withdrawn anytime, tax free
  • Earnings tax free if withdrawn at least five tax years after account opening and past age 59½, disabled or deceased
  • Withdrawal of earnings after age 59 ½ avoid 10% IRS additional tax for early distributions.
  • Withdrawals not required during your lifetime
  • Taxable as regular income.
  • Withdrawals after age 59½ avoid 10% IRS additional tax for early distributions
  • Required minimum distributions (RMDs) kick in after age 72 (unless you reached 70½ in 2019)
Beneficiaries
  • Except for spouse and certain others, must take distributions over 10 years
  • Owe tax on inherited accounts; except for spouse and certain others, must take distributions over 10 years
Bonus Points!
  • May withdraw up to $10,000 penalty free (taxable as regular income) to go toward first-time home purchase
  • May tap account to pay for college with no early-withdrawal fee
  • May withdraw up to $10,000 penalty free (taxable as regular income) to go toward first-time home purchase
  • May convert to Roth IRA via a “back door” no matter your income level
  • May tap account to pay for college with no early-withdrawal fee (taxable as regular income)
 

 

How do I choose an IRA?

So, which IRA is right for you? The answer largely depends on where you are today and where you think you’ll be tomorrow. As a general rule:

  • If you think your tax bracket will be higher when you withdraw than it is when you contribute — say, you’re just starting out in your career or simply want to forego a tax break now in favor of a potentially bigger one later—you could benefit from a Roth.
     
  • If you think your bracket will be lower when you withdraw — typically at retirement — than when you contribute, you might do better going the traditional route and paying taxes at that lower rate later.

(What if your crystal ball is on the fritz and you don’t have a clear view of what’s ahead? You might consider “hedging” your tax risk by investing through both types of accounts.) 

Even so, which type of IRA you can choose — and how much you can contribute — also depends on your age and adjusted gross income (AGI), an amount on your federal tax return that reflects your overall income minus certain deductions. (For a Roth, you’ll need to know your modified AGI [MAGI], which adds some uncommon deductions back to your AGI based on an IRS formula Opens in a new window .)

 

What you can do next

Traditional and Roth IRAs offer different tax benefits en route to a retirement nest egg (and maybe more). Which to choose depends on your current situation, future expectations and goals. And because the new SECURE Act scrambled certain rules, consider consulting your tax advisor before you invest.

 

Footnotes

Ira Hellman is a senior writer at Prudential.

 

This article was originally published on Aug. 15, 2017, and updated on Nov. 9, 2020, to reflect updates to the IRS tax code and SECURE Act legislation.

 

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