Roth IRA vs. Traditional IRA: Key Differences and SimilaritiesPersonal Taxes
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If I have one pet peeve when it comes to IRAs, it’s when some well meaning financial “expert” presents the Roth IRA as the only kind of IRA that matters.
After all — so the story goes — earnings are tax-free in a Roth IRA but only tax-deferred in a Traditional IRA, and doesn’t tax-free sound better than tax-deferred?
Unfortunately this is an overly simplistic view of the Roth IRA vs. Traditional IRA debate. Frankly, there’s no one-size-fits-all answer here.
The optimal thing to do in this situation is to sit down with a qualified financial advisor to discuss your current situation as well as your long-term financial goals and let him or her set out a gameplan for you.
But if you don’t have access to professional advice, the best you can do is educate yourself on the differences between Roth IRAs and Traditional IRAs and make an informed choice about which kind of account you will contribute to this year.
Roth vs. Traditional: Similarities
While Roth IRAs and Traditional IRAs are more different than they are similar, they do have some characteristics in common.
1. How Much You Can Contribute
For both the Traditional IRA and the Roth IRA, the maximum you can contribute is the lesser of your earned income for the year or $6,000 ($7,000 if you are age 50 or older) for both 2019 and 2020.
Note that this is the total amount you can contribute to your combined Traditional IRA and Roth IRA accounts.
You cannot contribute $6,000 to a Traditional IRA and an additional $6,000 to a Roth IRA in 2020.
You could, however, contribute some money to a Traditional IRA account and some money to a Roth IRA account as long as your total contribution to both accounts combined does not exceed $6,000 ($7,000 if you are age 50 or older).
2. When You Can Contribute
The deadline to contribute to both a Traditional IRA and a Roth IRA for tax year 2019 is April 15, 2020.
The deadline to contribute to both a Traditional IRA and a Roth IRA for tax year 2020 is April 15, 2021.
As you can see, even if you extend your tax return filing deadline for six months, this extension does not apply to your IRA contribution deadline.
3. Earned Income Requirement
For both Traditional IRAs and Roth IRAs, you must have earned income in order to contribute.
Earned income includes:
- Salaries and wages
- Self-employment income
- Non-taxable combat pay
The following kind of income is not considered earned income for IRA contribution purposes:
- Rental income
- Deferred compensation
- Gambling income
4. Retirement Age
59 1/2 years of age is when taxpayers may withdraw from both Traditional IRAs and Roth IRAs without penalty.
5. Spousal IRA
If your spouse is unemployed, and you file jointly, you can contribute to your spouse’s Traditional IRA or Roth IRA.
That said, the amount you contribute to both your own and your spouse’s IRA cannot exceed your earned income.
Roth vs. Traditional: Differences
The tricky thing about deciding whether to contribute to a Roth IRA or a Traditional IRA (or both) is that there are so many differences between the two accounts and therefore so many variables to consider.
1. When You Get the Tax Benefit
Both the Traditional IRA and the Roth IRA offer potential tax benefits, but the timing of these benefits differs between the two.
With a Traditional IRA, contributions you make are deductible in the year you make them insofar as you are eligible to take a Traditional IRA deduction (more on that later). However, when you withdraw money from your Traditional IRA in retirement, the amount you withdraw is taxed as income.
With a Roth IRA, you don’t get a deduction for the amount you contribute in retirement, but the earnings grow tax-free, and any distributions you take in retirement are not included in your taxable income.
2. Income Limitations
Traditional IRAs and Roth IRAs both have income limitations, but their respective limitations limit different things.
The Roth IRA’s income limitations limit who may contribute (directly) to a Roth IRA, while the Traditional IRA’s income limitations limit who may take a deduction for their Traditional IRA contribution. Anyone, no matter their income, may contribute to a Traditional IRA.
Here are the Traditional IRA income limitations on contribution deductibility:
|Single or head of household and you are covered by a retirement plan at work||2020: $65,000 or less |
2021: $66,000 or less
|2020: between $65,001 and $74,999 |
2021: between $66,001 and $75,999
|2020: $75,000 or more |
2021: $76,000 or more
|Married filing jointly and you're covered by retirement plan at work||2020: $104,000 or less|
2021: $105,000 or less
|2020: between $104,001 and $123,999 |
2021: between $105,001 and $124,999
|2020: $124,000 or more |
2021: $125,000 or more
|Married filing jointly and your spouse is covered by a retirement plan at work||2020: $196,000 or less |
2021: $198,000 or less
|2020: between $196,001 and $205,999 |
2021: between $198,001 and $207,999
|2020: $206,000 or more |
2021: $208,000 or more
|Married filing separately and you or your spouse is covered by a retirement plan at work||2020: Full deduction not permitted. |
2021: Full deduction not permitted.
|2020: between $0 and $9,999 |
2021: between $0 and $9,999
|2020: $10,000 or more |
2021: $10,000 or more
And here are the Roth IRA income limitations on contributing directly to a Roth IRA. Note that these rules can be worked around by using backdoor Roth IRA strategy.
|Single, head of household or married filling separately (if you did not live with spouse during year)||2020: less than $124,000|
2021: less than $125,000
|2020: between $124,000 and $138,999|
2021: between $125,000 and $139,999
|2020: $139,000 or more|
2021: $140,000 or more
|Married filing jointly or qualifying widow(er)||2020: less than $196,000|
2021: less than $198,000
|2020: between $196,000 and $205,999|
2021: between $198,000 and $207,999
|2020: $206,000 or more|
2021: $208,000 or more
|Married filing separately (if you lived with spouse at any time during year)||2020: Full contribution not permitted.|
2021: Full contribution not permitted.
|2020: less than $10,000|
2021: less than $10,000
|2020: $10,000 or more|
2021: $10,000 or more
3. When You Get Your Tax Break
With a Traditional IRA, you get a tax break now insofar as you can deduct your contribution to your account.
With a Roth IRA, you get a tax break later when you withdraw money from your account in retirement tax-free.
4. Withdrawing Contributions
Roth IRA contributions can be withdrawn from the account without penalty even before age 59 1/2.
Earnings on these contributions, however, will be taxed.
Apart from very limited exceptions, Traditional IRA contributions cannot be withdrawn from the account before age 59 1/2 without triggering taxes and a penalty on the entire withdrawn amount.
5. Required Minimum Distributions
When you turn 72 years of age, the IRS requires you to start taking distributions from your Traditional IRA account. These are known as required minimum distributions (RMDs).
Roth IRA accounts do not have RMDs.
Which Is Best For You?
Everyone’s situation is different, and only you can determine whether or not a Traditional IRA or a Roth IRA is right for you.
That said, here are some guidelines:
- Generally speaking, the lower your current tax bracket and the further away you are from retirement, the more advantageous a Roth becomes.
- If you’re planning to take some time off or otherwise foreseen a low-tax-bracket year in the near future, consider contributing to a Traditional IRA now and then converting to a Roth in a low-tax-bracket year.
- Remember, you can contribute to both a Traditional IRA and a Roth IRA in the same year!
Logan is a practicing CPA and founder of Choice Tax Relief and Money Done Right. After spending nearly a decade in the corporate world helping big businesses save money, he launched his blog with the goal of helping everyday Americans earn, save, and invest more money. Learn more about Logan.