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Individual retirement accounts (IRAs) can help you save more for retirement by paying less in taxes. Roth IRAs and traditional IRAs are both tax-advantaged retirement accounts you can open and fund on your own, but each has its pros and cons.
Traditional IRAs are funded with pretax dollars. They provide an immediate tax benefit and tax-deferred earnings as your money grows, but your distributions are fully taxable when you make withdrawals in retirement. Roth IRAs are funded with after-tax dollars, so you don't get a tax deduction now. However, your earnings and qualified withdrawals are tax-free, which translates to substantial tax savings.
Which account is better for you? Here are some basics to know about Roth IRAs and traditional IRAs, and how to go about choosing the right retirement account for your unique needs.
Roth IRA vs. Traditional IRA Comparison
| Roth IRA vs. Traditional IRA | ||
|---|---|---|
| Roth IRA | Traditional IRA | |
| Best for | Lifetime tax savings Both earnings and withdrawals are tax-free for the life of the account | Immediate tax deduction Contributions are excluded from taxable income now but withdrawals will be taxed in retirement |
| How it's funded | With after-tax dollars | With pretax dollars |
| How contributions are taxed | Contributions are not tax deductible | Contributions are tax deductible |
| How earnings are taxed | Earnings are tax-free You don't pay tax on capital gains, dividends or interest as your money grows or when you withdraw it | Earnings are tax-deferred You don't pay tax on capital gains, dividends or interest as your money grows, but do pay tax when it's withdrawn |
| How withdrawals are taxed | Distributions in retirement are tax-free if you meet guidelines | Distributions in retirement are fully taxed as regular income |
| How required distributions are taxed | No required minimum distributions (RMDs) | You must take RMDs each year starting at age 73 |
| Maximum annual contribution (2024) | $7,000 ($8,000 if you're 50 or older) Your contribution can't exceed your taxable compensation for the year | $7,000 ($8,000 if you're 50 or older) Your contribution can't exceed your taxable compensation for the year |
| Maximum income (2024) | Contribution limit Your Roth contribution may be phased out if your income exceeds IRS limits | Deduction limit Your tax deduction for a traditional IRA contribution may be reduced based on your income and participation in a retirement plan at work |
| Early withdrawal rules | 10% penalty when you withdraw earnings before age 59½ Roth contributions may be withdrawn tax-free at any time Five-year rule: Earnings may be withdrawn tax-free only after a Roth account has been open for five years | 10% penalty for any withdrawals made before age 59½ (with a few exceptions) Full withdrawal amount is also taxable as ordinary income |
| Distribution rules in retirement | Qualified distributions are tax-free | All distributions are taxed as regular income |
What Is a Traditional IRA?
A traditional IRA is a tax-deferred retirement account, meaning you'll pay taxes when you withdraw your money. As long as you meet income requirements, your contributions to a traditional IRA are tax deductible. As your money grows, you don't pay income or capital gains taxes on your earnings each year. By deferring taxes on earnings, your money stays in your account where it can continue to compound over time.
Because traditional IRAs are funded with pretax dollars and earnings aren't taxed along the way, distributions from traditional IRAs are fully taxable as regular income during retirement. For planning purposes, remember that a percentage of the money available to you in retirement from a traditional IRA will go toward paying taxes.
When to Choose a Traditional IRA
A traditional IRA might make sense for you if:
- You want to reduce your taxable income now
- Tax savings allow you to contribute more to your IRA
- Your tax bracket will be lower in retirement than it is now
Traditional IRA Example
Although you will eventually pay taxes on your traditional IRA funds, tax-deductible contributions might encourage you to save. For example, if you're in the 22% tax bracket, a $7,000 contribution saves you roughly $1,540 in taxes. In theory, a $7,000 contribution only costs you $5,460 ($7,000 - $1,540) net, making a maximum contribution more affordable. Immediate tax savings can serve as an incentive to contribute—or to contribute more.
What Is a Roth IRA?
Like a traditional IRA, a Roth IRA is a type of investment account that you can open on your own and use to save for retirement.
Unlike a traditional IRA, however, contributing to a Roth won't save you money on this year's taxes: Roth IRAs are funded with after-tax dollars, so your contribution isn't tax deductible. However, you may see greater tax savings over the long term with a Roth.
Once you put money into a Roth IRA, you typically don't pay taxes on it again. Your money grows tax-free as long as it's in your Roth account: no taxes on capital gains, dividends or interest. You won't pay taxes on qualified distributions in retirement either. For distributions to qualify, at least one of the following must be true:
- You are age 59½ or older
- You are permanently disabled
- You have inherited the Roth account
- You are purchasing your first home (limit $10,000)
With a Roth, you can also withdraw your original contributions (but not earnings) without tax or penalty at any point.
When to Choose a Roth IRA
A Roth IRA might be a good choice for you if:
- You don't need an immediate tax deduction
- You want the flexibility to withdraw your original contributions without penalty
- You want a tax-free source of income in retirement
Roth IRA Example
Say you invest $7,000 in a Roth IRA. Over the years, your money grows and compounds at an average rate of 6% annually. In 40 years, your $7,000 investment could be worth $76,702. Although you already paid taxes on your original $7,000 contribution, your $69,702 in earnings can be withdrawn tax-free in a Roth. If you had put $7,000 into a traditional IRA instead, you would pay taxes on the full $76,702 when you withdrew it.
Learn more >> How to Choose an IRA Provider
How to Determine Which Type of IRA Is Best for You
To decide between a traditional and a Roth IRA, consider your income, tax liability, savings goals and overall finances—both now and in retirement. Your priorities may determine which choice is best for you.
Here are some questions to consider when sizing up your options.
- Do you need an immediate tax deduction? A traditional IRA contribution may reduce your taxable income and lower your tax bill for the current tax year. Roth IRA contributions are not tax deductible because they are made with after-tax funds.
- Do you meet Roth IRA income limits? Eligibility for a Roth IRA begins phasing out when your adjusted gross income reaches $146,000 for single and head of household tax filers, $230,000 for married couples filing jointly and $10,000 for married people filing separately.
- Do you contribute to a retirement plan at work? Participating in a 401(k) plan at work may affect your eligibility to deduct a traditional IRA contribution. Phase-outs begin at $77,000 for single filers and heads of household, $123,000 for married couples filing jointly and $10,000 for married people filing separately.
- Will you earn less when you retire? Deferring taxes on your contributions and earnings with a traditional IRA makes sense if you expect to be in a lower tax bracket when you retire. Better to pay taxes at a lower rate later, the reasoning goes. However, if you expect your tax bracket to be the same or higher in retirement, a Roth IRA may give you a bigger tax benefit over the long term. You won't get an immediate tax break now, but you also won't pay taxes on your (potentially much larger) contributions plus earnings when you withdraw money in retirement.
- Do you want tax-free income in retirement? Distributions from traditional IRAs and 401(k) plans are fully taxable in retirement; distributions from Roth accounts are tax-free. Putting some of your money into a Roth diversifies your retirement portfolio and creates a potential source of tax-free retirement income.
- Do you need the flexibility to withdraw funds before retirement? You can withdraw funds from your traditional IRA early, penalty-free, in only a few cases: for example, to put a down payment on a house. But, with a Roth, you can withdraw your original contributions (not earnings) at any time without tax or penalty.
Learn more >> How to Open an IRA
Alternatives to Roth and Traditional IRAs
Traditional and Roth IRAs are easy to find and easy to fund, which makes them great options for a wide range of people. But traditional and Roth IRAs aren't your only choices for retirement savings. Below are a few alternatives that may work as well or better in certain circumstances.
401(k) and Other Employer-Based Retirement Plans
Contributing to a 401(k), 403(b) or other employer-based retirement plan at work may offer benefits a traditional or Roth IRA doesn't. For example, contributions may be deducted automatically from your paychecks, and your employer may offer matching funds, which can give your savings an instant boost at no cost to you.
Contribution limits for 401(k) accounts are also higher than for IRAs. In 2024, employees can contribute up to $23,000 with a $7,500 catch-up contribution if you're 50 or older.
In addition to offering traditional retirement plans, some employers now offer Roth 401(k) plans that are similar to Roth IRAs.
Learn more >> Can I Have a 401(k) and an IRA?
SEP IRA
If you're self-employed or own a small business, you can set up a simplified employee pension, or SEP, plan for yourself and your employees. A SEP IRA is similar to a traditional IRA but with higher annual contribution limits. It also provides a way for employers to contribute to their employees' retirement.
For 2024, the SEP IRA contribution limit is $69,000 or 25% of compensation, whichever is less. Employers should note that all SEP IRA accounts must be funded at the same rate, so if you contribute 25% of your compensation to a SEP IRA, you must contribute 25% of each employee's compensation to theirs.
SIMPLE IRA
Small business owners can contribute to their own retirement as well as their employees' using a savings incentive match plan for employees, or SIMPLE IRA. A SIMPLE IRA lets employers with 100 or fewer employees establish a basic retirement plan that includes dollar-for-dollar employer matching up to 3% of compensation.
The 2024 contribution limit for SIMPLE IRAs is $16,000 with a $3,500 catch-up contribution for employees (and employers) 50 and older.
Taxable Investment Accounts
While traditional and Roth IRAs both carry significant tax advantages that help you grow your retirement savings over time, a taxable investment account can also help you save for retirement or other long-term goals. A taxable investment account, or brokerage account, enables you to invest in stocks, bonds, exchange-traded funds (ETFs), mutual funds, cryptocurrencies and more.
You won't enjoy a tax deduction on money you put into a taxable investment account. You'll also pay taxes on the investment gains, dividends and interest you earn along the way, which means you'll keep less of those earnings as your money grows.
On the other hand, you don't have to contend with contribution limits, income restrictions or early withdrawal penalties. Though you'll have to pay taxes on gains, you do not have to pay regular income taxes based on how much money you withdraw, as you would with a traditional IRA or 401(k). If you've maxed out on retirement contributions, a taxable investment account gives you an additional way to invest.
The Bottom Line
If choosing between a Roth IRA and a traditional IRA still feels daunting, you might consider choosing both. You can split the $7,000 annual IRA contribution limit between traditional and Roth accounts to get the best of both worlds, or choose the type of account that complements your 401(k): If you contribute to a traditional 401(k) plan at work, for instance, consider opening a Roth IRA to broaden your approach.
Now is also a great time to review your larger financial plan: Fine-tune your budget, look for tax savings, plan for large expenses like paying for college or buying a home, check your credit and create a consistent strategy for retirement savings. Looking at the bigger picture may help bring the relative pros and cons of choosing an IRA into focus.