Traditional IRA & Roth IRAs: Navigating Their Similarities & Differences

Traditional IRA & Roth IRAs: Navigating Their Similarities & Differences

March 15, 2024

Are you starting to invest and considering a Traditional IRA or Roth IRA? First of all, congratulations on saving for retirement! Your future self will thank you for it.

Although there are similarities between the two types of IRAs, there are also distinct differences.

Let’s cover how they are similar first.

Age Eligibility

Anyone with earned income can contribute to a Traditional or Roth IRA. There is no age limit.

Income Eligibility

For both Roth and Traditional IRAs, you must have earned income. Earned income is income from employment, not income from a pension, investments or social security for instance. Your earned income must be equal to or greater than the amount you contribute each year. For instance, if you make $5,000 in a year you can only contribute $5,000 to your IRA even though the maximum allowed is higher. If you are married filing jointly and do not have earned income yourself, you can also contribute based on your spouse’s earned income.

Annual Contribution Maximums

The IRS sets annual IRA contributions limits in early November for the upcoming year. The contribution maximum applies for both Traditional and Roth IRAs. For instance, in 2024 they have set the following:

  • $7,000 is the maximum for either an Individual Traditional or Roth IRA. If you are over the age of 50, you can contribute up to $8,000.
  • $7,000 is the maximum allowed for Roth and Traditional IRA accounts combined. You can max your Roth at $7,000 or your Traditional IRA at $7,000 (if you are under 50). You may also split the $7,000 between the two: $3,500 Roth and $3,500 Traditional = $7,000.
  • You cannot contribute $7,000 your Roth and another $7,000 to your Traditional IRA.

Income Phase Outs

Just as the IRS sets annual contribution maximums, they also determine income phase out limits where if you are above that income level you are no longer eligible to contribute. Both deductible Traditional IRA and Roth IRA contributions come with these income eligibility requirements, however, the limits are different for each type of IRA. You can always contribute to a nondeductible Traditional IRA regardless of income.

All limits are based on your MAGI (modified adjusted gross income). Below are the limits the IRS has established for 2024:

Income limits (phase out limits) for Traditional IRAs:

  • Single filers covered by a workplace plan: $77,000 - $87,000
  • Married filing jointly, IRA contributor is covered by workplace plan: $123,000 to $143,00
  • Married filing jointly, IRA contributor is not covered by workplace plan but married to someone who is covered: $230,000 to $240,000

Income limits (phase out limits) for Roth IRAs:

  • Single filers: $146,000 - $161,000
  • Married filing jointly: $230,000 – $240,000

To view the current contribution maximums and income limits – visit www.IRS.gov

Now let’s get into how they are different.

Withdrawals

  • Roth: Withdrawals can be taken out tax-free and penalty free, provided you’re age 59½ or older and you have met the minimum account holding period (5 years). You can access the contributions at any time without taxes or penalty. There are also special provisions made for withdrawals due to life events such as a first-time home purchase.
  • Traditional: Withdrawals are penalty free once you turn 59 ½ but taxed as current income. Withdrawals taken before 59 ½ are subject to 10% penalty on top of ordinary income taxes (some exceptions made to the 10% penalty if you meet the IRS definition of qualifying for a “hardship”).

Tax Benefits

  • Roth: Contributions are made with post tax dollars. You don’t get a tax deduction for your contributions, but your earnings grow tax-free. You won’t have to pay taxes on your withdrawals in retirement.
  • Traditional: Contributions are made with pretax dollars. You receive a tax deduction for your contributions in the year you make them (if you meet income eligibility). When you withdraw the money in retirement, you will owe taxes on both the contributions and earnings.

Required Minimum Distributions

  • Roth: No mandatory minimum withdrawals
  • Traditional: The IRS requires individuals to begin taking money out of the account at age 73 (for those born between 1/1/1951 and 12/31/1959 – see the Blog Taking the Mystery Out of Your RMD Age)

Wealth Transfer

  • Roth: Upon your death, withdrawals from an inherited Roth IRA would be tax free for your beneficiaries. This makes a Roth a great account to leave to your heirs as they will have no tax burden to access the funds.
  • Traditional: Upon your death, an inherited Traditional IRA requires your beneficiary to pay ordinary income taxes on any withdrawals making it less desirable to inherit than a Roth IRA.

Both a Traditional IRA or a Roth IRA can be a smart choice for planning for retirement and by evaluating a few key factors you can decide which is best for you. If you are still unsure which is the best fit for your needs, a financial advisor can help walk you through making an informed decision.

Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual.

A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.

Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.