Roth IRA vs. Traditional IRA

A Roth IRA allows you to contribute after-tax funds into a retirement account. When you decide to withdraw, you may do so tax-free if you have satisfied the holding period and age requirements. Meanwhile, your money can be invested within the account to potentially increase its value. The goal is for your investments to generate dividend and interest payments.

A Roth account comes with contribution limits.

For 2023, you can contribute up to $6,500 if you’re under 50 or $7,500 if you’re age 50 or older. Note that the deadline for contributions is the following year’s unextended federal tax deadline.

You can take your contributions from the Roth account at any time without taxes or penalties. However, withdrawing any of the growth earned from investments before age 59 1/2 and/or a 5-year holding period may trigger income taxes and/or a 10% tax penalty on those funds. There are a few exceptions to this rule, such as withdrawals to pay medical expenses, a higher education or to buy a first home.

Consult with a financial advisor before setting up a Roth IRA and before you contribute to it. A financial counselor will weigh in on whether a Roth makes sense for you and your retirement goals. Additionally, if you own a Roth IRA and expect to take an early withdrawal, speak to an advisor to make sure you understand and plan for the tax implications.

Roth IRAs have advantages and disadvantages. Weigh both sides carefully when thinking about contributing to one.

A traditional IRA is a retirement account that offers tax-free contributions and growth. You can contribute up to $6,500 to this account in 2023 (or $7,500 if you’re age 50 or older).

When you put money into a traditional IRA, you can deduct some or all of that contribution from your yearly income taxes if you fall below the modified adjusted gross income (MAGI) income ceiling ($83,000 for single filers and $136,000 for joint filers). You then can make investment decisions about the assets you want.

The goal is to have your investment grow tax-free until you’re ready to withdraw during retirement. Unlike a Roth IRA, any money you withdraw from your traditional IRA is taxed as regular income.

You must be at least 59 1/2 to take money out of a traditional IRA account to avoid a tax penalty. If you’re younger, you’ll pay a 10% tax penalty in addition to the normal income taxes on the withdrawal. Similar to the Roth IRA, there are exceptions to the penalty under certain circumstances.

At some point, after you reach your full retirement age, you’ll be required to take a specific amount of money out of your account each year. The amount of this Required Minimum Distribution (RMD) depends on how much you have saved and other factors. Before setting up a traditional IRA, talk to your financial advisor about your savings goals and other considerations.

Traditional IRAs have advantages and disadvantages. Consider these when thinking about using one of these accounts to save for your retirement.

Roth and traditional IRAs differ in four key areas: taxation, RMDs and contribution limits, withdrawal penalties, and estate planning.

It’s essential to consider your individual financial situation, long-term goals, and risk tolerance when deciding which type of IRA is best suited for you. Each area is a topic to review with your financial advisor as you map out your retirement planning strategy. A financial advisor can help analyze your circumstances, guide you through the complexities of IRAs, and tailor a personalized retirement plan that aligns with your specific needs and aspirations.

Traditional IRAs are funded from pre-tax dollars. Also, your investments grow tax-deferred until you withdraw your money. You must pay taxes on the money you take out, but if you take out money before you turn 59 1/2, you’ll pay an additional 10% tax penalty.

Money that you put into a Roth IRA comes from after-tax dollars. You won’t owe tax on any investment growth or future withdrawals. However, if you withdraw money before age 59 1/2 and/or before the 5-year holding period, you may owe taxes and/or a 10% tax penalty on the portion of that withdrawal derived from investment income. The portion derived from your contributions is tax-free regardless of when it is withdrawn.

Contribution limits are the same for traditional and Roth IRAs: $6,500 if you are younger than 50 and $7,500 if you’re 50 or older (for 2023).

The difference between the two accounts is in RMDs. You must take some money from your traditional IRA once you turn 73.

The amount depends on your life expectancy and other factors.

Roth IRAs have no RMD requirements.

Both IRA types have a 10% withdrawal penalty for people younger than age 59 1/2. The same set of exceptions also applies to both Roth and traditional.

However, early withdrawal penalties only apply to earnings withdrawn from a Roth IRA. You can take out any money you put into the account without incurring a penalty. In short, early withdrawals from a Roth IRA are less punishing than those from a traditional IRA.

You can pass both traditional IRAs and Roth IRAs to your heirs. However, withdrawals from an inherited traditional IRA are taxed as ordinary income, while withdrawals from an inherited Roth IRA are generally tax-free.

One type of IRA isn’t always better than the other. Each serves a specific purpose. To choose the right one for you, consider your current financial circumstances and future goals. The primary consideration when choosing between the two types usually comes down to taxation.

Think about your current and future tax obligations and your estate planning needs. You might prefer a traditional IRA if you expect your income to fall significantly during retirement. You might want a Roth IRA if you intend to leave money in that account for your heirs. However, keep in mind that you may not be eligible for a Roth IRA if your income is higher than the maximum threshold.

Many people contribute to both types of accounts to take advantage of their different benefits. Investing in both provides tax diversification. Since it’s not known what tax rates will be in the future or what your taxable income in retirement might be with RMDs, then it might make sense to have some of your retirement savings in a traditional IRA and some in a Roth IRA.

Talk to your financial advisor about what options work best for you.