Traditional IRA vs. Roth IRA

Traditional IRA vs. Roth IRA

March 01, 2024

It's tax season! You still have until April 15th to discuss funding IRA accounts for 2023. We thought this would be a good time to highlight some differences between a Traditional IRA and a Roth IRA.

The main differences between a Roth IRA and a Traditional IRA are centered around their tax treatment, contribution rules, and distribution characteristics. Here's a breakdown of these key distinctions:

Tax Treatment:

  • Roth IRA: Contributions to a Roth IRA are made with after-tax dollars, meaning there is no immediate tax deduction. However, qualified withdrawals, including both contributions and earnings, are tax-free during retirement.
  • Traditional IRA: Contributions to a Traditional IRA may be tax-deductible, providing an immediate reduction in taxable income. However, withdrawals during retirement are subject to ordinary income tax.

Contribution Rules:

  • Roth IRA: There are income limits for Roth IRA eligibility, and direct contributions are not allowed if income exceeds a certain threshold. Contributions are not tax-deductible, but there is no age limit for making contributions, and individuals can contribute as long as they have earned income.
  • Traditional IRA: There are no income limits for contributing to a Traditional IRA, but tax deductibility is subject to income and participation in employer-sponsored retirement plans. Individuals can contribute until the age of 72, but contributions are no longer allowed once the individual reaches this age.

Required Minimum Distributions (RMDs):

  • Roth IRA: Roth IRAs do not impose RMDs during the account owner's lifetime. This means individuals can let their investments grow tax-free for as long as they choose.
  • Traditional IRA: Traditional IRAs require RMDs starting at age 72. The IRS mandates that account holders withdraw a minimum amount annually, and these withdrawals are subject to income tax.

Early Withdrawals:

  • Roth IRA: Contributions (but not earnings) can be withdrawn at any time without taxes or penalties. Qualified withdrawals of earnings are tax-free after the age of 59½ or under specific conditions.
  • Traditional IRA: Early withdrawals before the age of 59½ may incur a 10% penalty in addition to income tax. Some exceptions, such as certain medical expenses or first-time home purchases, may allow penalty-free early withdrawals.

Estate Planning:

  • Roth IRA: Roth IRAs can be advantageous for estate planning, as they do not have RMDs during the account owner's lifetime, and qualified distributions are tax-free for beneficiaries.
  • Traditional IRA: Traditional IRAs are subject to RMDs, and distributions to beneficiaries are taxable, potentially impacting the after-tax value passed on to heirs.

Choosing between a Roth IRA and a Traditional IRA often depends on individual financial circumstances, tax considerations, and retirement goals.

This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.