Both are individual retirement accounts, and both let your investments grow without yearly taxes on dividends or gains. The difference is when you pay tax:
- Traditional IRA: contributions may be tax-deductible now, and you pay income tax on withdrawals in retirement.
- Roth IRA: you contribute money you've already paid tax on, and qualified withdrawals in retirement are tax-free.
A simple rule of thumb: if you expect your tax rate in retirement to be higher than it is today, a Roth tends to come out ahead. If you expect it to be lower, a traditional IRA tends to win. Many people aren't sure, and splitting contributions between the two is a reasonable hedge.
Side by side
| Traditional IRA | Roth IRA | |
|---|---|---|
| Tax break | Possible deduction now | Tax-free qualified withdrawals later |
| Who can contribute | Anyone with earned income | Earned income, below IRS income limits |
| Deduction limits | Phased out at higher incomes if you or your spouse have a workplace plan | Not applicable |
| Required minimum distributions | Yes, starting at age 73 | None during the original owner's lifetime |
| Early withdrawals | Taxed, plus 10% penalty before 59½ (some exceptions) | Contributions can come out any time tax- and penalty-free; earnings follow stricter rules |
The yearly contribution limit is the same for both and is shared between them: if the limit is $7,000 and you put $4,000 in a Roth, you can put at most $3,000 in a traditional IRA that year. The IRS adjusts the limit periodically and allows a higher limit from age 50. Check the current figures on irs.gov before you contribute.
How the tax difference plays out
Say you contribute $5,000 a year for 30 years and earn a hypothetical 6% a year. The account grows to about $395,000 either way.
- Traditional: you deducted $5,000 a year along the way. In retirement, every dollar you withdraw is taxed as ordinary income. At a 22% rate, the $395,000 is worth about $308,000 after tax.
- Roth: you got no deduction, but the whole $395,000 comes out tax-free if withdrawals are qualified.
That doesn't make the Roth automatically better. The traditional IRA saved you tax every year you contributed. If you invested those savings, the gap narrows. If your tax rate in retirement is the same as when you contributed, the two come out about equal. The deciding factor is the tax rate now versus later.
Reasons to lean toward a Roth
- You're early in your career and expect to earn more later.
- You want flexibility: Roth contributions (not earnings) can be withdrawn any time.
- You don't want required minimum distributions forcing withdrawals in your 70s.
- You want to leave tax-free money to heirs.
Reasons to lean toward a traditional IRA
- You're in a high tax bracket now and expect a lower one in retirement.
- You need the deduction to lower your taxable income this year.
- Your income is above the Roth limits and you qualify for the deduction.
The withdrawal rules
Roth IRA. Earnings come out tax- and penalty-free when you're at least 59½ and the account has been open at least five years. Before that, earnings can be taxed and penalized, with exceptions such as up to $10,000 for a first home purchase.
Traditional IRA. Withdrawals are taxed as income. Before 59½, a 10% penalty usually applies on top, with exceptions such as certain higher-education expenses, a first home purchase (up to $10,000) and disability.
If your income is too high for a Roth
Some people make nondeductible contributions to a traditional IRA and convert them to a Roth, often called a "backdoor Roth". The tax treatment depends on whether you hold other pre-tax IRA money. This is a case where it's worth getting advice from a tax professional first.
Where to open one
Most online brokers and robo-advisors offer both account types with no account fees. Inside the IRA, you choose the investments: low-cost index funds, target-date funds or a managed portfolio. Fees still matter inside an IRA, since they reduce what the tax advantages can grow.
This is general information, not tax or investment advice. Rules have exceptions, and your situation may differ.