Differences Between Traditional and Roth IRAs, and How to Choose Between Them
There's a wide range of reasons why you may be thinking about contributing to an individual retirement account, or IRA. Maybe you're ready to start building for your retirement wealth, but your company doesn't offer a 401(k). Or perhaps you've just changed jobs and want to roll your old 401(k) savings into an IRA. Putting some of your savings into this type of tax-advantaged account can be an important step in moving toward your financial goals and making your hard-earned money go further.
Before you make the commitment, it's important to know your options so you can make the best choice for your goals. One of the key considerations is deciding which type of IRA you'll choose: traditional or Roth.
Breaking down the differences
The main distinction between traditional and Roth IRAs is how and when you receive your tax perks.
With traditional IRAs:
- You don't pay taxes on your contributions in the year you make them, although you'll pay taxes on withdrawals later
- You'll typically lower your taxable income the year you contribute, which can qualify you for more tax credits, like student loan deduction credit
- Your IRA is taxed at your income tax rate when you withdraw funds, which may be lower during retirement
- You're subject to stricter rules on eligibility and withdrawal
With Roth IRAs:
- You pay taxes on contributions now and then pay nothing when you withdraw funds
- Contributions don't lower your taxable income in the year you make them
- You may benefit from flexible rules on eligibility and withdrawal—for example, while traditional IRAs require you to start withdrawing minimum required amounts each year starting at age 70 ½, a Roth lets you grow your savings tax-free for as long as you like
Understanding eligibility and withdrawals
With traditional IRAs, anyone earning an income can contribute to an account. However, once you turn 70 ½, you're no longer allowed to contribute to a plan. Any withdrawals before you reach the age of 59 ½ will come with some kind of financial penalty, and you're required to start withdrawing at age 70 ½ if you've left your account untouched. Select circumstances, such as a first-time home purchase or a qualified withdrawal for higher education, might not incur a penalty fee but could be taxed.
A Roth IRA doesn't have age limits, but it does have income limits. While the exact limits change every few years, individuals must earn below a certain amount set by the federal government in order to contribute. For married couples, the limit is based on household income and is higher than for individuals.
Withdrawals are more flexible with a Roth, because you may be able to avoid the early-withdrawal penalty if you've had the account for at least five years and need the money due to permanent disability, or if $10,000 of it's for your first-time home purchase. Both the Roth and traditional IRA have the same contribution limits.
Which IRA account is right for me?
The easiest way to determine which IRA is right for you and your family is to ask yourself how you wish to receive your tax benefits. If you believe that the tax deductions will benefit you the most now, it may be best to stick with a traditional IRA. If you prefer not to worry about taxes later in life, you might benefit from setting up a Roth IRA.
Both traditional and Roth IRAs can be essential investment tools for retirement. Talk with a trusted financial advisor about which IRA fits your unique situation and how to maximize your savings now for a better tomorrow. Moreover, you could use our save for retirement calculator to better understand your retirement needs.
A few financial insights for your life
This information is provided for educational purposes only and should not be relied on or interpreted as accounting, financial planning, investment, legal or tax advice. First Citizens Bank (or its affiliates) neither endorses nor guarantees this information, and encourages you to consult a professional for advice applicable to your specific situation.