Understanding the difference between a traditional IRA and a Roth IRA may seem as difficult as learning a foreign language. The most noteworthy difference is how each IRA is taxed. But there are other differences that are also important to understand to help you make the best decisions to fund your retirement.
Congress created IRAs through the Employee Retirement Income Security Act of 1974 to incentivize individuals to save for retirement. IRAs were initially limited to workers who did not have pension coverage through their employer. The Economic Recovery Act of 1981 changed that, making all workers and their spouses eligible to open IRAs.
For both traditional and Roth IRAs, funds are typically taxed only once – either before the money is contributed to the account or when it is withdrawn – based on the type of IRA.
A traditional IRA is an individual retirement account that you typically fund with pre-tax dollars, thereby decreasing your taxable income in the year you make a contribution because the contributions may be tax-deductible. However, you may pay tax on the distribution.
Roth IRAs were created through the Taxpayer Relief Act of 1997 to provide an alternative to traditional IRAs. Roth IRAs are named after former U.S. Senator William Roth of Delaware, who sponsored the bill.
With Roth accounts, you won’t receive any tax deductions today but can generally take withdrawals in retirement without paying taxes. You may benefit from a Roth IRA if you’re young, currently in a lower tax bracket or have most of your investments in traditional IRA accounts or retirement plans and are looking to increase tax diversification and flexibility in retirement.
Both traditional IRAs and Roth IRAs have the same annual contribution limit. There is no difference.
If you are eligible, you can contribute up to 100% of your taxable compensation or the contribution limit, whichever is lower. Contribution limits are set every year by the IRS and are tied to cost-of-living adjustments. In 2022, the annual contribution limit is $6,000 if you are age 49 or younger. If you are 50 or older, the IRS allows you to make an additional annual contribution of $1,000 as a catch-up contribution. Keep in mind your total contribution can be no more than $6,000 if you are 49 or younger ($7,000 if you are age 50 or more) for all of your traditional and Roth IRAs combined.
In 2023, the annual contribution limit is $6,500 if you are age 49 or younger. If you are 50 or older, the IRS allows you to make an additional annual contribution of $1,000 as a catch-up contribution. Keep in mind your total contribution can be no more than $6,500 if you are 49 or younger ($7,500 if you are age 50 or more) for all of your traditional and Roth IRAs combined.
Taxable compensation is generally taxable income that is received from a job or self-employment, and may include:
Sources of income that do not qualify as taxable compensation include:
The eligibility rules for the two types of IRAs are different.
You may contribute to a traditional IRA (up to the maximum IRS annual contribution limit) if you or your spouse (if married) have taxable compensation, regardless of the amount you earn; however, the amount of your contribution that can be deducted from taxes is limited based on the amount you earn and whether you or your spouse participate in an employer-sponsored plan, such as a 401(k) or SIMPLE plan.
You can fully fund a Roth IRA (up to the maximum IRS annual contribution limit) if you have taxable compensation, and your modified adjusted gross income (MAGI):
| Filing Status | 2023 MAGI | 2022 MAGI | Contribution |
|---|---|---|---|
| Single or Head of Household | Below $138,000 | Below $129,000 | Full Contribution |
| Between $138,001-$152,999 | Between $129,001-$143,999 | Partial Contribution | |
| $153,000 or above | $144,000 or above | No Contribution | |
| Married Filing | $0 | $0 | Full Contribution |
| Married Filing Jointly | Below $218,000 | Below $204,000 | Full Contribution |
| Between $218,001-$227,999 | Between $204,001-$213,999 | Partial Contribution | |
| $228,000 or above | $214,000 or above | No Contribution |
| Filing Status | 2023 MAGI | 2022 MAGI | Contribution |
|---|---|---|---|
| Separately (Living with spouse) | Between $0-$9,999 | Between $0-$9,999 | Partial Contribution |
| $10,000 or above | $10,000 or above | No Contribution | |
| Married Filing Separately (Not living with spouse at any time during the year) | Below $138,000 | Below $129,000 | Full Contribution |
| Between $138,001-$152,999 | |||
| $153,000 or above | Between $129,000-$143,999 | Partial Contribution | |
| $144,000 or above | No Contribution |
*If your MAGI falls in one of these given ranges, your tax advisor can help you determine your exact IRA contribution maximum.
You can also fund a traditional or Roth IRA on behalf of your spouse. If he or she earns little to no income, you may be able to contribute up to the maximum IRS annual contribution limit for that account, too, as long as you file a joint tax return.
The most notable difference between a traditional IRA and a Roth IRA is the deductibility of contributions and taxability of withdrawals. If you contribute to a Roth IRA, you will pay taxes on the money before it is deposited into your IRA. However, earnings and withdrawals are generally tax-free. Traditional IRAs are the opposite. Contributions to traditional IRAs are typically tax-deferred, depending on the owner’s income and employer plan participation. However, withdrawals are taxed like income. Thus, if you deduct your contributions, you will later pay taxes on them and any investment earnings at withdrawal.
Roth IRA contributions are not tax deductible. However, your traditional IRA contributions or a portion of them may be deductible, depending on your income and whether you or your spouse participates in an employer retirement plan.
The Saver’s Credit, officially known as the Retirement Savings Contributions Credit, is a nonrefundable tax credit for making contributions to your IRA or employer-sponsored retirement plan. Eligible taxpayers can receive a credit of up to $1,000 if you file an individual tax return or $2,000 if you file a joint tax return, which can help you reduce the amount of tax you owe. The Saver’s Credit can be claimed in addition to the tax deduction for contributions to traditional IRAs or other employer-sponsored retirement plans. Eligible taxpayers who contribute to a Roth IRA may also be able to claim the credit to lower their tax bill.
A required minimum distribution (RMD) generally only applies to traditional IRAs. It is the minimum amount that you must withdraw from your traditional IRA by April 1 of the year after you reach age 73 and by December 31 of every year thereafter. If you fail to take your RMD by the deadline, you will be subject to a hefty 25 percent excise tax on the amount of the RMD you did not distribute. A major benefit of a Roth IRA is that you generally aren’t required to withdraw a specific amount at or by any certain time.
The term withdrawal is used when you take money out of your IRA. It is sometimes used interchangeably with distribution, which means you receive money from your IRA. Withdrawal/distribution rules differ to some degree for a traditional IRA versus a Roth IRA. However, they are similar in that if you withdraw funds before you are age 59 ½, you may be subject to a 10% early withdrawal penalty, unless you qualify for an exception (set by the IRS -- more on this below).
For traditional IRAs, there are generally three types of withdrawals:
Roth IRAs generally have four types of withdrawals:
There are exceptions to the 10% tax penalty that apply to both early distributions from traditional IRAs and Roth IRAs. Per the IRS, for the 10% penalty to be waived, the distributions must meet one or more of the following criteria:
You generally must meet two criteria to be able to roll over your employer retirement plan to an IRA:
Additionally, Roth 401(k) assets may only be rolled over to a Roth IRA. Pre-tax 401(k) assets can be rolled over to a traditional or a Roth IRA. But, if you roll over pre-tax 401(k) assets to a Roth IRA, it's considered a Roth conversion, and the amount that's rolled over will be taxed.
It's also important to know that there are differences between employer plans and IRAs. Make sure you understand your options before rolling over. A financial advisor can also help you determine whether rolling over makes sense for you.
Yes, you can transfer your IRA to another provider at any time without tax consequences or tax reporting as long as the assets move directly from your current IRA provider to your new IRA provider.
A rollover may also be an option. A rollover must be deposited into the same IRA or another eligible IRA by the 60th calendar day (not business days) from the day following receipt of the cash or assets. If the 60th calendar day falls on a Saturday, Sunday or holiday, the rollover must be deposited on the last business day before the
Both traditional and Roth IRAs can be inherited. When someone inherits an IRA, they will have to take distributions from the inherited IRA by a certain deadline, regardless of whether it's a traditional or Roth IRA. The amount they must take from the inherited IRA and the deadline to take it vary depending on the beneficiary.
The main difference between traditional and Roth IRAs from an inheritance perspective is who pays the taxes. With a traditional IRA, the heir pays taxes on the distributions at their income tax rate. With a Roth IRA, the original owner paid taxes on the contributions, so the heir can generally take tax-free distributions.
If you have questions about inheriting an IRA or leaving one to a loved one, consider discussing this with a financial advisor.
Investing in accounts with different tax treatments can provide you flexibility (and potentially higher after-tax income) in retirement. As a result, you should consider contributing to both traditional and Roth IRAs. However, the focus of your contributions may change depending on your life stage and tax situation. For example:
A traditional IRA tends to be more beneficial when:
A Roth IRA tends to be more beneficial when:
Get started on navigating IRAs by finding an Edward Jones financial advisor today. Our financial advisors can help you understand what questions to ask as you decide which IRA might be right for you. They'll work with you to build a solid long-term strategy as you plan for and enjoy your retirement.
Edward Jones, its employees and financial advisors cannot provide tax or legal advice. You should consult your attorney or qualified tax advisor regarding your situation. This content should not be depended upon for other than broadly informational purposes. Specific questions should be referred to a qualified tax professional.