May 15, 2017
Here’s the drive-thru window answer to the “Should I contribute to a Roth IRA or a traditional IRA?” question:
A Roth IRA is a stronger choice if you expect your tax rate to be higher in retirement. A traditional IRA makes more sense if you expect your tax rate to be lower in retirement.
Of course, there are a lot of details between the lines of our abridged Roth IRA versus traditional IRA answer. Let’s review them.
Roth vs Traditional IRA: What’s the difference?
While both account types are powerful tax-advantaged ways to save for retirement, there are some key differences between them:
|Roth IRA||Traditional IRA|
|Taxes||If you believe your tax rate will be higher when you retire, choose a Roth IRA to pay taxes now and not when you're in a higher bracket.||If you believe your tax rate will be lower when you retire, choose a traditional IRA to save on taxes today and pay at a lower rate later.|
|Income restrictions||If you are in a higher income bracket, your eligibility may be limited.||If you are in a higher income bracket or have access to a workplace retirement plan (or your spouse does), your tax deduction may be limited.|
|Early withdrawal penalties||Roths offer no penalties on withdrawals of contributions, though earnings withdrawals may be taxed and penalized if certain conditions aren't met.||All unqualified early withdrawals are subject to a penalty of 10%.|
|Required minimum distributions||There is no requirement to take distributions unless the account has been passed to an heir.||Beginning at age 70 1/2, your account will be subject to required minimum distributions.|
Making the decision
It’s possible the table above made the choice clear for you — and it’s also possible you may still have no clue which is right for you. If you’re still in the dark, here are some rules of thumb:
When a Roth may make sense
If you’re currently in a low tax bracket — anything in the low 20% range or below — a Roth IRA is probably a good choice. (See our breakdown on income tax brackets if you’re unsure where you stand today.) This is more likely the case if you’re in the early stages of your career, or you’ve changed careers and will be at a higher rung of the income ladder when you retire.
Why a Roth? Withdrawals from a Roth IRA in retirement are not subject to income tax. So when your future flush self starts drawing income from your Roth IRA savings, you won’t have to pony up income taxes to the IRS when your tax rate has gone up.
When a traditional IRA may make sense
If you’re in a high tax bracket or close to retirement age, a traditional IRA makes the most sense. Why? A traditional IRA enables you to take a tax deduction when it benefits you most.
After their 40s or mid- to late 50s, people tend to migrate to a lower tax bracket due to full- or semi-retirement, taking on lower-paying but more meaningful work, or simply needing to draw less income if expenses have gone down. And since withdrawals from a traditional IRA are taxable as income as long as they’re taken after age 59½, by choosing a traditional IRA you save again on the backside because you’re taking out that money when you’re in a lower tax bracket.
Know which account you need?
- If you’re ready to compare account providers for either type of account, see our analyses of the top traditional IRA providers and the top Roth IRA providers.
- If you’d like to focus on the details of one account type, review our traditional IRA guide or Roth IRA guide to learn how to get the most from these accounts.
Undecided? Let’s dig deeper
Here’s a more extensive rundown of the differences between traditional IRAs and Roth IRAs.
The biggest difference between a Roth and a traditional IRA is how and when you get a tax break:
- The tax advantage of a traditional IRA is that your contributions are tax deductible.
- The tax advantage of a Roth IRA is that your withdrawals in retirement are not taxed.
In other words, with a traditional IRA, you pay taxes when you take distributions in retirement (or if you make withdrawals prior to retirement). A Roth IRA operates in reverse: You pay taxes upfront, because your contributions are not deductible. Earnings on your investments grow tax-free in a Roth and tax-deferred in a traditional IRA.
See the table below for an illustration of these accounts in action.
|If your tax rate is LOWER in retirement||If your tax rate is HIGHER in retirement|
|Current tax rate|
|Tax rate in retirement|
|After-tax value in retirement*||$555,902||$572,898||$555,902||$472,835|
*Assumes a 7% annual return and 30-year time horizon; traditional IRA includes invested tax savings.
Both traditional and Roth IRAs come with eligibility rules and restrictions that determine how much you can contribute. Assuming you’re eligible for both, you can contribute to a traditional and a Roth IRA during the same year, as long as the total amount does not exceed the maximum allowable contribution limit of $5,500, or $6,500 if you’re age 50 and over.
The amount you’re allowed to contribute to a Roth IRA, however, isn’t an all-or-nothing scenario — it’s a “heck, yeah!” “sorta” and “sorry, not this year, cowboy” scenario. Roth contribution limits are based on household income, and those at higher incomes often find themselves squeezed out of Roth eligibility either partially or completely. (See our Roth IRA contribution limits page for details on how much your income will allow you to contribute.)
There are no income restrictions for contributing to a traditional IRAs — titans of industry and everyday workers alike are eligible to open and contribute up to the annual limit — but your income can affect how much of your IRA contribution you’re allowed to deduct from your taxes.
In addition to the size of your paycheck, traditional IRA deductibility takes into account tax filing status and whether you and/or your spouse are covered by an employer’s retirement plan. For details on how this is calculated, see our page on traditional IRA contribution limits.
It’s generally not a good idea to withdraw money from an IRA early, and the rules do a good job of deterring it: You must be at least age 59½ to avoid early withdrawal penalties and taxes. But sometimes dipping into your retirement savings is unavoidable.
When you take money out of a traditional IRA before retirement, the IRS socks you with a hefty 10% early-withdrawal penalty and taxes the money you take out as income at your current tax rate. (See our page on traditional IRA distribution rules for more details, as there are some exceptions to this rule.)
The Roth has better terms for those who break the seal on the retirement savings cookie jar: It allows you to withdraw contributions — money you put into the account — at any time without having to pay income taxes or an early withdrawal penalty. However, there are different rules when it comes to accessing the earnings from your Roth IRA: That money is subject to the five-year rule that states that any earnings withdrawn before your first Roth IRA contribution is at least 5 years old may be subject to income taxes and a 10% early withdrawal penalty.
See our detailed explanation of Roth IRA withdrawal rules for more details and the exceptions that apply to Roth accounts.
Required minimum distributions
Let’s fast-forward to your 70th birthday. Six months after you blow out the birthday candles you’ll be subject to required minimum distributions (RMDs) from your traditional IRA. Remember, the IRS is still waiting to tax that money it has left alone for so long.
Taking RMDs is not a big deal if you’re retired at age 70½ and are already living off your retirement savings. But if you’re a financially flush member of the silver-haired set who doesn’t necessarily need to withdraw funds from the IRA, the requirement is less appealing. Not only will you have to interrupt the growth of what’s in your account by making withdrawals, but if you’re still working and want to contribute more to a traditional IRA, you’re out of luck. No additional contributions are allowed after age 70½.
For those who live long and continue to prosper, the Roth is less stringent: It has no required minimum distribution rules (unless you inherit a Roth IRA — see our Roth RMDs post for details on that). You’re free to let your savings stay put in the account and continue to grow tax-free as long as you live. You’re also allowed to continue contributing to a Roth past the age of 70½. If you’re fortunate enough to not need to tap into the account for income right away and you want to pass on a larger account to your heirs, Roth is the way to go.
OK, what’s next?
If you’re now ready to open an IRA, browse the articles below for step-by-step guidance:
How and Where to Open a Roth IRA
How and Where to Open a Traditional IRA
Updated June 27, 2017.