What’s the difference between Traditional and Roth IRA?
In broad strokes, one will save you taxes when you file your yearly taxes and the other will allow you to potentially use that money if you retire early tax free.
Let’s deep dive into the difference and whether or not you are eligible to utilize it.
These ideas are based on my personal experience and opinion and should not be considered professional financial investment advice. Furthermore, the ideas and strategies should never be used without first assessing your own personal and financial situation, or without consulting a financial professional.
- What Are Traditional And Roth IRAs
- Differences In How They Are Taxed
- Differences In Eligibility
- Differences In Withdrawal Rules
- Conclusion: What's The Difference Between Traditional And Roth IRA?
- How Can You Succeed Financially?
- Are you living your best life or are you stressed about paying the bills?
- About Dwight Scull
What Are Traditional And Roth IRAs
An IRA, or Individual Retirement Account, is a personal savings plan that offers tax advantages. There are two types of IRAs: traditional and Roth. Both have different rules and benefits.
A traditional IRA allows you to deduct your contributions from your taxes. This means you pay less in taxes now, but you will be taxed on the money when you withdraw it in retirement.
A Roth IRA does not offer an up-front tax deduction, but your withdrawals are tax-free in retirement.
Which one is right for you depends on your current tax situation and your retirement goals.
If you want to lower your taxes now, a traditional IRA may be the better choice. If you want to avoid paying taxes on your withdrawals in retirement, a Roth IRA may be the better choice.
Differences In How They Are Taxed
There are two types of Individual Retirement Accounts (IRAs), the traditional IRA and the Roth IRA, each with different tax consequences.
Contributions to a traditional IRA may be tax deductible, depending on your income and whether you or your spouse are covered by an employer-sponsored retirement plan. With a traditional IRA, you pay taxes on the money when you withdraw it in retirement.
The Three Legs Of Retirement
Note in some states you will also pay taxes on your social security (if it exists) payment as well. It is a good idea to have a three-legged stool of pretax, post-tax and recurring income in your retirement.
With a Roth IRA, you contribute after-tax dollars, so there is no up-front tax deduction. However, qualified withdrawals from a Roth IRA are tax free in retirement.
There are income limits for both traditional and Roth IRAs. If your income is too high, you may not be able to contribute to either type of account. There are also different rules for how much you can contribute each year.
Differences In Eligibility
There are a few key differences between traditional and Roth IRAs when it comes to eligibility.
There is no age limit for contributing to a Roth IRA.
Traditional IRAs have stricter eligibility requirements.
For example, you must have earned income in order to contribute to a traditional IRA.
There is an annual contribution limit of $6,000 (or $7,000 if you’re over the age of 50) into an IRA. Finally, you must begin taking the required minimum distributions (RMD) from your traditional IRA at age 70½. The Roth IRA has no such RMD.
There are also income requirements as well, but not in the way you may think.
If you make more than $78,000 if single and $129,000 if married filing jointly you cannot contribute to a Traditional IRA.
If you make more than $144,000 if single and $214,000 if married filing jointly you cannot contribute to a Roth IRA.
If you are a high-income individual or couple you will need to look to other sources to invest your wealth. My investment of choice is found in my article How to be your own bank.
Differences In Withdrawal Rules
The biggest difference between traditional and Roth IRA withdrawal rules is when you have to start taking money out of the account.
With a traditional IRA, you can begin taking penalty-free withdrawals at age 59½. However, required minimum distributions (RMDs) must begin by age 70½.
This means that even if you don’t need the money in your account, you are still required to take out a certain amount each year starting at age 70½.
With a Roth IRA, there are no required distributions during the owner’s lifetime.
Also with a Roth IRA, you can pull out any of the money you have put in without penalty. You cannot take out any of the money the IRA has earned in interest without penalty until age 59½.
How Can You Succeed Financially?
There is a clear path toward financial success and security.
It isn’t just being a worker for 45 years. Although for some it may involve that.
If you want to know what practical steps are needed to achieve financial freedom read my article on how to achieve financial freedom.
Conclusion: What’s The Difference Between Traditional And Roth IRA?
Assuming you don’t make over the legal limits then an IRA is a great way to save for retirement.
If you are curious about a backdoor IRA I discuss that here.
Best Order To Save
The best way to save for retirement is by investing in an IRA. Traditional to reduce your tax burden today and a Roth to reduce it in the future.
If you have a 401k matching option at your job please maximize that match first and if eligible then maximize your IRA and finally then maximize the rest of your 401k.
If you have the option to invest in a Roth 401k and you are NOT planning to retire early then use a traditional 401k to take advantage of the tax savings now. To learn more about the tax advantages you have available to you read this article.
Are you living your best life or are you stressed about paying the bills?
In this quick 2-page PDF, I cover 5 ways you can get your financial life back on track.
I used to live paycheck to paycheck and after years of paying off debt and maximizing my investments I am now able to save and invest more than 45% of my wife and I’s gross pay.
This allows me to live comfortably (not a crazy rich person) and sleep better at night. If you want this let me know where I can send it to you below.
Wow, you read a lot to get here. Can you do me a favor, please? Can you leave a comment if this was helpful to you or if I missed something? Alternatively, it would help me out a lot if you shared this content with those that might need to see it. Thanks, you are the best!
Traditional IRA Summary
There are two main types of IRAs: traditional and Roth. Both have their own benefits and drawbacks, so it’s important to understand the difference before you make a decision.
With a traditional IRA, you get a tax deduction for your contributions. This means that your money can grow tax-deferred until you retire. However, you will be taxed on your withdrawals in retirement.
With a Roth IRA, you don’t get a tax deduction for your contributions. But all of your withdrawals in retirement are tax-free.
So which is right for you? It depends on your individual circumstances.
About Dwight Scull
I have been married to my wonderful wife, Rebecca, who puts up with me since 1999. I am a proud father to my Gen Z, son, and daughter-in-law. Grandfather to my favorite granddaughter who was born in 2021.
I lost my mom, father-in-law, and 12 others in 2013 and was DEEPLY in debt. I started reading and watching all the financial info I could find.
I chipped away at my debt and went from a negative $105k net worth having one home paid off, no credit card debt, and saving/investing 45%+ of my gross salary.
I used these daily habits to lose 100 pounds and keep it off.
I believe that you can overcome any challenge you face if you just take small daily actions and be consistent with them. It is how you will be financially successful.
Join my free Facebook group to get a ton of free resources to help you get out of debt, learn how to invest your money and work toward having the option of retiring early.