Traditional IRA vs. Roth IRA
Trying to decide between a Traditional IRA or a Roth IRA? Here are the differences.
Note: The article below refers to the 2017 tax year. You have until the tax filing deadline—April 18, 2018—to make a 2017 contribution. Click here for Roth IRA Eligibility rules, or visit these links for current contribution limits or current income limits .
The type of individual retirement account you choose can significantly affect your and your family’s long-term savings. So it’s worth understanding the differences between traditional IRAs and Roth IRAs in order to select the best one for you.
Here are the key considerations:
Anyone with earned income who is younger than 70½ can contribute to a traditional IRA. Roth IRAs don t have age restrictions, but they do have income-eligibility restrictions: Single tax filers, for instance, must have modified adjusted gross incomes of less than $133,000 in 2017 to contribute to a Roth IRA. (Contribution limits are phased out starting with a modified AGI of $118,000, per IRS guidelines.) Married couples filing jointly must have modified AGIs of less than $196,000 in 2017 in order to contribute to a Roth; contribution limits are phased out starting at $186,000. You can also see the full income limits here .
Both traditional and Roth IRAs provide generous tax breaks. But it’s a matter of timing when you get to claim them. Traditional IRA contributions are tax deductible on both state and federal tax returns for the year when you make the contribution; withdrawals in retirement are taxed at ordinary income tax rates. Roth IRAs provide no tax break for contributions, but earnings and withdrawals are generally tax-free. So with traditional IRAs, you avoid taxes when you put the money in. With Roth IRAs, you avoid taxes when you take it out in retirement.
Future Tax Rates
Do you expect your income to increase or decrease in retirement?
Deciding to contribute to a traditional or Roth IRA should depend on whether you expect your income tax rate in retirement to be higher or lower than what you currently pay. That’s because it determines whether the tax rate you pay on your Roth IRA contributions (today’s tax rate) is higher or lower than what you’d pay on your traditional IRA’s withdrawals in retirement.
Of course, it’s hard to predict what federal and state tax rates will be 10, 20 or even 40 years from now. But you can ask yourself some basic questions to help determine your personal situation: Which federal tax bracket are you in today? Do you expect to your income, including Social Security, to increase or decrease in retirement? Although conventional wisdom suggests that gross income declines in retirement, taxable income sometimes does not. Think about it. Once the kids are grown and you stop saving for retirement, you lose some valuable tax deductions and tax credits. This could leave you with higher taxable income in retirement, even after you stop going to work.
What about tax rates? Do you expect your tax rate will be higher or lower when you retire? Given today’s historically low federal tax rates and large U.S. deficit, many economists believe federal income tax rates will rise in the future—meaning Roth IRAs may be the better long-term choice.
One major difference between traditional IRAs and Roth IRAs is when the savings must be withdrawn. Traditional IRAs require you to start taking required minimum distributions (RMDs), mandatory, taxable withdrawals of a certain percentage of your funds, at age 70½, whether you need the money at that point or not. Roth IRAs, on the other hand, don’t require any withdrawals during the owner’s lifetime. If you have enough other income, Roth IRAs can continue to grow tax-free throughout your lifetime, making them ideal wealth-transfer vehicles.
Beneficiaries of Roth IRAs don’t owe income tax* on withdrawals and can stretch out distributions over many years.
*Beneficiaries may still owe estate taxes —particularly if Congress drops estate tax exclusion limits after 2012.
Both traditional and Roth IRAs allow owners to begin taking penalty-free, “qualified” distributions at age 59½. However, Roth IRAs require that the first contribution be at least five years before qualified distributions begin in order to avoid being taxed.
Extra Benefits Considerations
It’s also worth factoring in some of the specific rules and benefits of traditional and Roth IRAs. Here’s a breakdown:
- Contributions to traditional IRAs lower your taxable income in the contribution year. That lowers your adjusted gross income, helping you qualify for other tax incentives you wouldn’t otherwise get, such as the child tax credit or the student loan interest deduction.
- Up to $10,000 can be withdrawn without the normal 10% early-withdrawal penalty to pay for qualified first-time homebuyer expenses and for qualified higher education expenses. Hardships such as disability and certain levels of unreimbursed medical expenses may also be eligible, However, you’ll pay taxes on the distribution.
- Roth contributions (but not earnings) can be withdrawn penalty- and tax-free at any time, even before age 59½.
- Five tax years after the first contribution, you can withdraw up to $10,000 of Roth earnings penalty-free to pay for qualified first-time homebuyer expenses.
Keep in mind that Congress can change these rules at any time. So while these are the rules today, they may be very different when you retire.