When choosing a retirement account for investing, you have several options, but which one is the best? The short answer is that the “best” account for you will depend on your individual financial situation. In general, the Traditional IRA and Roth IRA are some of the most popular “savings account” choices among those preparing for retirement.
An individual retirement account (IRA) is a tax-advantaged way to save money for your retirement. There are two main types of IRAs (Traditional and Roth) that mainly differ in how and when your money is taxed.
Key differences between Traditional and Roth IRAs:
- Traditional IRAs provide the tax break today, while Roth IRAs provide tax benefits in the future.
- Traditional IRA distributions are treated as income, while Roth IRA distributions are not taxed.
- Roth IRAs have income restrictions that may disqualify some people from participating.
In this article, we’ll dive deeper into the differences between these IRAs to help you decide which option is right for you.
What Is A Traditional IRA?
A Traditional IRA is a retirement savings account that allows an individual to get a tax deduction for money that is set aside for retirement. The money put into an IRA and the investment earnings on those contributions are not taxed until they are withdrawn.
Traditional IRAs are the most common type of IRA, and if your employer doesn’t offer a retirement plan, or you’ve maxed out your 401k and are looking for a way to save more, a Traditional IRA could be a great way for you to save additional funds (pre-tax) for your retirement.
To be eligible for a Traditional IRA, a person must have received earnings from work during the year and be under age 70 ½. You can open a Traditional IRA through a brokerage, mutual fund company, or even at your local bank, and the money you contribute can be invested in stocks, bonds, mutual funds CDs and other investments. In 2022, you can contribute up to $6,000 per year to an IRA ($7,000 if you are over 50 years old).
In a Traditional IRA, your contributions may be tax-deductible depending on your income and your access to an employer plan. Withdrawals from a Traditional IRA are taxed as ordinary income. You can always contribute to a Traditional IRA no matter how much money you make – but if you’re a high earner, you may not be able to deduct the money you put into the account.
See the IRA Deduction Limits Here.
The ability to deduct the full $6,000 ($7,000 if you’re 50 or older) contribution depends on a few factors:
- Your adjusted gross income
and…
- If you have access to an employer-sponsored retirement savings account (such as a 401k).
Adjusted Gross Income
In 2022, you can deduct the full $6,000 of contributions to your Traditional IRA if:
- you’re single and your adjusted gross income is $68,000 or less; or
- you’re married, you file a joint tax return, and together your gross adjusted income is $109,000 or less.
- you’re married, but you and your spouse file separately, and your personal adjusted gross income is less than $10,000.
Employer-Sponsored Retirement Programs
If your employer DOES offer a retirement program, plan accordingly. Your Traditional IRA contribution might not be fully deductible if you choose to invest in an IRA over your employer-sponsored program. This rule is in place in favor of employer-sponsored programs. If either you or your spouse are covered by an employer retirement plan, you may want to get financial advice. You may be entitled to only a partial deduction or no deduction at all, depending on your income and your filing status. Your deduction begins to decrease (sometimes the IRS calls this “phase out”) when your income rises above a certain amount. Those same deductions are eliminated altogether when it reaches a higher amount. These amounts vary depending on your filing status.
If your employer DOES NOT offer a retirement plan, you’re usually allowed to deduct your full $6,000 contribution to a Traditional IRA. However, there is an exception – if your company doesn’t offer a retirement plan, but your spouse’s company does, you can make the full $6,000 contribution ONLY IF you and your spouse’s combined gross income is less than $214,000 (in 2022) AND you and your spouse file your taxes jointly.
How much can you contribute to a Traditional IRA?
In 2022 an individual can contribute up to $6,000 dollars ($7,000 for those age 50 or older), but that person cannot contribute more than their taxable compensation for that year.
You can no longer contribute into a Traditional IRA once you reach 70½ years old.
Allowed withdrawals from a Traditional IRA?
Funds can be withdrawn at any time, but there is a 10% tax penalty for withdrawing the funds before age 59 ½.
Distributions must start by April 1 of the year following the year in which a person reaches age 70½.
What Is A Roth IRA?
A Roth IRA is a retirement savings account that allows your money to grow tax-free. In contrast to a Traditional IRA, you don’t get the upfront tax break in a Roth IRA, as you are investing after-tax dollars into your account. But, because you are contributing money after taxes, you don’t pay income taxes on your money when you go to withdraw it. Investment options for Roth IRAs include almost anything you want: index funds, life cycle funds, individual stocks, or other alternative investments.
So let’s say you invest $6,000 after-tax each year into your Roth IRA, and thirty years later when you retire it’s worth $180,000 (This is just an example. Could be more, could be less). When you withdraw that $180,000, you pay no taxes on it because with a Roth, you don’t get a deduction for contributions but you can make qualified withdrawals in retirement 100% tax-free.
Roth IRAs do not have age restrictions, but they do have income-eligibility restrictions:
In 2022, in order to be able to contribute to a Roth IRA you must meet one of the following criteria:
- Single tax filers must have a modified adjusted gross income of less than $1144,000
- Married couples filing jointly must have a modified adjusted gross income of less than $214,000
- Married couples living together but filing separately must have a modified adjusted gross income of less than $10,000
Choosing a Roth IRA could be the right choice for you if you think you may be in a higher tax bracket once you retire. And, you don’t have to take required minimum distributions from a Roth IRA at age 70½ like you do with a Traditional IRA. That allows your money to continue growing until you actually need to use it and you can continue making new contributions as long as you have earned income for the year.
How much can you contribute to a Roth IRA?
The contribution limit is the same as a Traditional (In 2022) = $6,000 if you are under 50… and $7,000 if you are 50+ years old.
You can make contributions into a Roth account at any age.
Allowed withdrawals from a Roth IRA?
You can withdraw contributions at any age without penalty. However, withdrawals of “earned interest” before age 59½ may be subject to taxes and penalties.
Exceptions To Earned Interest Penalty:
- If you are under 59½, you can withdraw up to $10,000 of Roth earnings penalty-free to pay for qualified first-time home-buyer expenses, provided at least five tax years have passed since your initial contribution.
Is A Traditional IRA Or Roth Better?
Traditional and Roth IRAs both have their advantages and their disadvantages. Which type is “better” truly depends on your current and future financial situation.
If you’re trying to decide whether to contribute to a Roth IRA or a Traditional IRA:
- A Roth IRA may be a better option for you if you expect to be in the same (or higher) tax bracket during your retirement years.
- If you’re earning a lot of income now and expect to have a lower tax rate in retirement, then a Traditional IRA would probably make more sense.
Take A Look At This Table To See The Differences Between A Traditional and Roth IRA:
Differences | Roth IRA | Traditional IRA |
Tax benefits | No tax deduction on contributions
Interest earned in the IRA is tax-free. |
Tax deduction on contributions
Interest earned in the IRA is tax-deferred until you withdraw funds. |
Contribution limits | $6,000 age 49 and younger; $7,000 age 50 or older | $6,000 age 49 and younger; $7,000 age 50 or older |
Income limits | Income affects how much you can contribute to a Roth IRA | Income does not affect how much you can contribute to a Traditional IRA
But…Income (and if you participate in an employer-sponsored retirement plan) can affect how much you are able to deduct. |
Early withdrawal penalties | Withdrawals of earned interest before age 59½ may be subject to taxes and penalties. | Withdrawals made before age 59½ are taxed at your tax rate at the time of the withdrawal and may be subject to a 10% penalty. |
Age requirements | Contribute at any age | Contribute until age 70½ |
Distributions | Take contributions out at any time without paying additional taxes or a penalty.
Take earnings out without tax or penalty once you are 59½ or older (if the money has been in the IRA for at least five years). |
Distributions taken after age 59½ are taxed at your tax rate at the time of the distribution. |
Required minimum distributions | No mandatory withdrawals during your lifetime | You must begin taking required minimum distributions at age 70½. |
What Are The IRA Contribution Deduction Limits in 2022?
Here is a chart from the IRS which outlines how much of your IRA contributions you are able to deduct on your taxes:
Filing status | Modified AGI | Maximum contribution |
Married filing jointly or qualifying widow(er) | Less than $204,000 | $6,000 ($7,000 if 50 or older) |
$204,000 to $214,000 | Reduced Contribution | |
$214,000 or more | Not eligible | |
Single, head of household or married filling separately (if you did not live with spouse during year) | Less than $129,000 | $6,000 ($7,000 if 50 or older) |
$129,000 to $144,000 | Reduced Contribution | |
$144,000 or more | Not eligible | |
Married filing separately (if you lived with spouse at any time during year) | Less than $10,000 | Reduced Contribution |
$10,000 or more | Not eligible |
Does A Roth IRA Earn Money?
The short answer to if a Roth IRA can earn money is – it can, as long as you make the right investments.
Unlike a savings account, which comes with its own interest rate that adjusts periodically, Roth IRAs don’t pay an interest rate.
While banks offer IRAs, limited investment options include savings accounts or certificates of deposit. , These investments offer lackluster returns because of the low yields offered on those types of accounts.
To access more lucrative investments, you may look into opening your IRA at a brokerage firm (in-person or online).
No matter where you open your Roth IRA (bank, brokerage firm or other investment avenue), you’ll want to pay close attention to the costs. For example, a broker might charge you transaction fees to buy and sell investments, as well as annual fees (referred to as “expense ratios”), and these costs will reduce your overall investment return.
Can You Lose All Of Your Money In An IRA?
It is an unlikely scenario – but, yes. It is possible to lose all of your money in an IRA. An example of this would be if you put all of your stock into one company (and didn’t diversify your investments) and that company becomes worthless or the business closes. In this case, you would lose all of the money you invested. But, for both Traditional and Roth IRAs that experience loss – you can deduct a percentage of the loss (usually around 2% of your adjusted gross income).
Want to know which retirement plans offer tax benefits? Read our article here.
Kate writes about retirement benefits for retirementinsurance.org. She has a Masters Degree in Social Work (MSW). She has over a decade of experience in assisting elderly and disabled populations navigate governmental and private programs to obtain the monetary assistance they need to lead better lives. As she watched her parents begin their own retirement journeys and navigate similar systems to obtain Social Security, Medicare and other retirement benefits, she gleaned a further personal knowledge about the topic and is eager to share what she has learned with others.