Prepare for your future, today. Add more freedom and flexibility into your retirement plan by learning the difference between a Roth and a traditional IRA (individual retirement account).
An IRA is a retirement account outside of a 401(k) created through your workplace or a retirement account that exists in place of having a 401(k). Contributing to an IRA can provide another way of adding to your savings while providing tax advantages.
How much you can contribute to an IRA is based on your income. In the 2023 tax year the maximum contribution is $6,500. If you are older than 50-years-old, you can contribute an added $1,000 per tax year. High-income earners are ineligible to use a Roth account or have limited access to them depending on income. These limits apply across all your IRAs, so even if you have multiple accounts, you can’t contribute more than the maximum.
When choosing to open an IRA, you’ll decide between a Roth and a traditional IRA. An Ameritas financial professional can help you choose the IRA that best meets your savings timeframe and financial situation.
What is a traditional IRA?
With a traditional IRA, taxes are deferred. That means taxes aren’t owed on either the money you contribute or the interest that it earns until you withdraw it from the account. Earnings are reinvested so your money has the potential to grow over time, potentially offering stronger long-term outcomes than taxable accounts. Read this blog to learn more about the power of tax-deferral.
Most people contribute to their traditional IRA using income that has already been taxed, generally by their employer, and then claim a tax deduction for the amount they contribute that year when they file their taxes.
There may be limits on the amount of your contribution that you can claim as a tax deduction. The deduction may be limited if you or your spouse is covered by a retirement plan at work and your income exceeds certain levels. If you want to claim a tax deduction equaling the amount of your contribution in the year you invest the funds in your traditional IRA, your income must be below a certain threshold, according to the IRS deduction limits.
- Self-employment income.
- Taxable alimony and separate maintenance.
- Nontaxable combat pay.
- Taxable non-tuition fellowship and stipend payments.
You generally must start taking withdrawals, called required minimum distributions (RMDs) from your traditional IRA when you reach age 72 (73 if you reach age 72 after Dec. 31, 2022).1
What is a Roth IRA?
Roth IRAs are funded with after-tax dollars—you’ve already paid taxes on the money you contribute. However, unlike a traditional IRA, the contributions are not tax-deductible, but once you start withdrawing funds, the money is tax-free, even the interest that your account has earned, as long as it’s not an early withdrawal.
Since the money you invest in a Roth IRA generally grows tax-free, earnings are reinvested so your money has the potential to grow over time, potentially offering stronger long-term outcomes than taxable accounts.
Roth IRA imposes restrictions set by the IRS each year. In the 2023 tax year, maximum contributions decrease if you earn above $138,000 as a single filer and $218,000 as a married couple filing jointly.
What’s the difference between a Roth and traditional IRA?
The differences between a Roth and traditional IRA primarily lie within the tax treatment of each.
- With a traditional IRA, you can receive potential tax deductions for your contribution now, whereas Roth contributions are made after you’ve paid taxes on them.
- For a Roth IRA, you don’t need to withdraw money at all, and a traditional IRA requires distribution after a certain age.
Some similarities exist between the two. In both cases:
- Both have tax advantages. Earnings are either tax-deferred with a traditional IRA (you pay taxes when earnings are withdrawn) or tax-free with a Roth IRA (you don’t pay taxes on the earnings).
- The early withdrawal penalty for both a traditional and Roth IRA is 10% of the earnings withdrawn before age 59½. The account also has to be at least five years old to avoid the penalty. Contributions can be withdrawn at any time without penalty. Some exceptions may allow penalty-free withdrawals in certain IRS-approved situations.
Why should I choose one over the other?
Why a traditional IRA? If you think you will contribute to the same tax bracket or a lower tax bracket by the time of your retirement, a traditional IRA might be most suitable. If you expect your tax rate to increase over time, contributing to a Roth IRA means you can take advantage of your lower tax rate now and not be taxed at a potentially higher rate when you retire.
Simply put, either enjoy the benefits of tax-free withdrawals in the future with a Roth or take advantage of tax benefits today with a traditional IRA.
Start saving early
Start contributing to an IRA, whether you choose a Roth or traditional, right away to begin accumulating savings for your retirement. Just getting started? Read this blog for helpful tips and the importance of starting young.
Need help with your financial goals?
While you can learn more about our products on this website, this information is no substitute for the guidance of a qualified professional. If you’re serious about assessing your financial wellness, contact a financial professional.
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