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Roth IRA Or Traditional IRA: Which Should You Choose

When it comes to a Roth IRA Vs. Traditional IRA, it all depends on when you want your tax break. But, when in doubt, choose a Roth IRA. Here’s why.

Roth IRA Vs. Traditional IRA

Table of contents

    As you probably know by now, you’re going to need a lot of money if you want to retire in this day and age.

    So it’s good to see that average balances are going up with retirement accounts.

    But how do you know if you’re using the best possible retirement account for your exact situation?

    For example, did you know if you make too much money and have access to a 401(k) at work, you might be losing out on valuable tax breaks when contributing to an IRA?

    In this article I’ll review both Roth IRAs and Traditional IRAs—including the similarities and differences—so you can see which option is best for you.

    Roth IRA vs. Traditional IRA

    Traditional IRARoth IRA
    Contribution Amount$5,500; $6,500 if you’re over 50 years old$5,500; $6,500 if you’re over 50 years old
    Age RestrictionsOnce you hit 70 1/2 years old, you can no longer contributeNone
    Income RestrictionsNoneMust make less than $135,000 per year
    TaxesContributions are tax-deductibleTax-free withdrawals
    WithdrawalsRequired minimum distribution at 70 1/2 You can withdraw your money (tax-free) at any time after 59 1/2


    If you’re trying to decide between a Roth IRA and a Traditional IRA, you’re not alone. I was in this situation recently. Historically I’d always had a Roth IRA, but when it came time to roll some funds over to my new account with
    Betterment, I had a choice to make—Roth IRA or Traditional IRA.

    Both types of IRAs are excellent retirement accounts—but they’re each for different people in different situations. Before you choose one, consider some of the following key attributes of each type:

    Contribution amount

    Both Traditional IRAs and Roth IRAs have the same contribution amount per tax year—$5,500 (based on the 2018 guidelines). This limit jumps to $6,500 if you’re over 50 years old (called a ‘catch-up’ contribution).

    • Winner: Tie—both have the same limits on contribution

    Age restrictions

    This is an uncommonly known thing, but Traditional IRAs have an age restriction by which you can contribute money. Once you hit 70 1/2 years old, you can no longer contribute funds to a Traditional IRA. You have to be under that age and have earned income. A Roth IRA, on the other hand, does not have any age restriction—so you can contribute to one as long as you’d like.

    • Winner: Roth IRA—there are no age restrictions

    Income restrictions

    In order to contribute to a Roth IRA, you have to have a modified adjusted gross income of less than $135,000 per year if you’re filing single. Married couples who file jointly can have a MAGI up to $199,000 if they’d like to contribute to a Roth IRA. These numbers are current as of the 2018 tax year but can change based on the year.

    A Traditional IRA doesn’t have income restrictions—so you can contribute to one regardless of how much you make. This makes for a sound option for those who are making more than the maximum to contribute to a Roth IRA.

    There are, however, limits by which you stop getting tax deductions if you’re already being covered by a retirement plan at your job. If this is the case, once you pass a certain threshold, you either get a partial deduction or no deduction at all. For example, married couples filing jointly and making over $99,000 per year would get no deduction.

    • Winner: Traditional IRA—despite the deduction restrictions, it allows people with any income to contribute

    Taxes

    One of the biggest benefits of having a Roth IRA is the tax-free withdrawals. In most cases, any earnings and withdrawals you make in retirement won’t be hit with income taxes. This is because the money you deposit into a Roth IRA has already been taxed. I’ll discuss more below on who this will benefit most.

    Traditional IRAs also enjoy tax benefits, but at a different time. As I alluded to above, your contributions to a Traditional IRA are tax-deductible on both the federal and state level. This means you get a tax break during that tax year, but you’ll have to pay income tax on the withdrawals when you take money out in retirement.

    • Winner: Tie—both have tax benefits, but they come at different times

    Withdrawals

    Here is where you’ll find one of the biggest differences between the two types of IRAs. With a Roth IRA, you can withdraw your money (tax-free) at any time after 59 1/2 without any penalties—granted that money has been in the account for at least five years. If you don’t need the money, you can let it sit there and grow. And since there are no age restrictions, you can continue to contribute.

    Traditional IRAs, on the other hand, require you to take money out once you hit 70 1/2 years of age. This amount is called the required minimum distribution, or RMD. The challenge is that these withdrawals are not only mandatory, but they’re taxable. So if you reach age 70 1/2 and you have no need for the money, you’re stuck and you still have to take it out and pay the taxes.

    • Winner: Roth IRA—not being forced to withdraw money is always nice…

    Where to open a Roth or Traditional IRA overview

    BettermentAlly InvestPersonal Capital
    Best ForHands-off investingEvery day tradersComplete wealth management
    Fees0.25% yearly0.30% yearly0.89% up to $1 million
    Services Offered
    • Managed portfolio
    • Access to certified financial planner
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    • Self-directed trading
    • Managed portfolio
    • Personalized asset allocation
    • Fee analyzer
    • Portfolio analysis
    • Net worth tracker
    • Budgeting

    Where to open a Roth or Traditional IRA

    By now you’re an expert on IRAs, right? So it’s time to open your first retirement account (or another one if you’ve decided you want a different type).

    Here are three of our most highly recommended brokers to do this at.

    Betterment

    I personally have my IRA with Betterment and I absolutely love it. I have two degrees in finance and an extensive background in investments and stock valuation—so I could pick my own stocks if I wanted to. But something about the roboadvisor is liberating. I love not having to worry about constantly changing investments and rebalancing my portfolio. I just pick a risk level and Betterment does the rest.

    Learn more about Betterment here.

    Ally Invest

    The cool thing about Ally Invest is the two options you get for managing your portfolio. They have a roboadvisor option, which like Betterment, will automatically rebalance your portfolio and choose your investments for you.

    This is nice if you want a hands-off approach. But if you do want to pick your own investments, Ally Invest comes with some of the cheapest fees available. They also have a very deep selection of investment options and their platform is super easy to use. I highly recommend.

    Learn more about Ally Invest here.

    Personal Capital

    Personal Capital now has more than just an awesome wealth management tool to track your finances. They offer complete wealth management services for a variety of net worth levels.

    Personal Capital is slightly more expensive than some of the others, but they make up for it with a more high-touch service. They have advisors that are specialized and will work with you to establish a portfolio that makes the most sense for you and your situation.

    Learn more about Personal Capital here.

    Why should I choose a Roth IRA or Traditional IRA?

    Now that you know a little more about the similarities and differences, let’s explore why you’d want to use one of these. Both Roth and Traditional IRAs are awesome retirement accounts that were put in place by the government to help and encourage people to save more for retirement. Because of that, they come with excellent tax benefits, among some other benefits.

    Regardless of whether you choose to invest in a Roth or Traditional IRA, you’ll get some type of tax break on your contributions. With a Traditional IRA, you get a tax break in the year you contribute the money (assuming you don’t make too much money and have access to a 401(k) at work). With a Roth, you’ll pay taxes on the income you earn and ultimately contribute to the account, but you’ll pay no taxes when you withdraw it later.

    You’ll also avoid crazy high taxes when you sell a stock. Known as the Capital Gains Tax, you’re taxed at a rate as high as 20 percent on the earnings you make from selling a stock when you do this in a regular, taxable investment account. You avoid these taxes when you do your trading in a retirement account like a Roth IRA or Traditional IRA.

    My recommendation is to take full advantage of, and max out if you can, an IRA. If you have the ability to, I’d suggest maxing out your 401(k) first (since it reduces your taxable income), then max out an IRA.

    Who is a Roth IRA or Traditional IRA best for?

    As I stated before, both of these types of IRA are good for certain people. Here are some recommendations on when to open which type of account.

    Open a Roth IRA if…

    1. You expect your tax bracket to be higher when you retire. Since your withdrawals are tax-free, you’re saving money by contributing taxed money now and saving money on the back end when you retire.
    2. You’re planning to buy your first home soon. If you’re under 59 1/2 years old, you can take out up to $10,000 of earnings from your Roth IRA without any penalty if it’s going toward the purchase of your first home.
    3. You need to take money out for an emergency. With a Roth IRA, you can withdraw your contributions at any time without penalty. There are specifics here, though, so consult a tax professional if you’re unsure on how this works.

    Open a Traditional IRA if…

    1. You expect to be in a lower tax bracket when you retire. Since you get tax credits now, if you think you’ll be making less in retirement and want to save money, take deductions on your contributions now, then pay income tax later.
    2. You want to take advantage of certain tax breaks. Because you receive deductions on your contributions with a Traditional IRA, you’re actually lowering your taxable income. In many cases, this puts people into a bucket to take advantage of other tax breaks they might not otherwise get with a higher taxable income. Again, consult a tax professional here.
    3. You want to buy a home OR have another emergency. You get the same benefit with a Traditional IRA as you do with a Roth on the $10,000 withdrawal for a home purchase. One benefit a Traditional IRA has, though is for certain hardships. For things like medical expenses and disability, you may be able to avoid paying the early withdrawal penalty to cover these types of expenses. There are a lot of guidelines on this though, and you certainly don’t want to make a mistake with this type of thing so consult a professional. Also, know that you’ll still have to pay taxes on the money even if you avoid the penalty for withdrawing.

    When in doubt, choose a Roth IRA

    I’ve had both types of accounts and I’ve been around the investment and tax world for quite some time (I’ll reiterate here that I’m not a tax or investment professional) and can tell you that a Roth IRA just comes with fewer complexities.

    If you’re just starting out and don’t know what to do, by default I would start with a Roth IRA. It has plenty of tax benefits and you aren’t tied down to withdrawals at a certain age. Plus, if you need money you can take your contributions out without a penalty.

    Summary

    Saving and investing for retirement is critical. If you’re not doing it—you need to start right away. An IRA is a great, tax-beneficial way to sock your money away for your golden years. But picking one can be complex. By now you should know which account type would benefit you more.

    Read more

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    About David Weliver

    David Weliver is the founding editor of Money Under 36. He's a cited authority on personal finance and the unique money issues we face during our first two decades as adults. He lives in Maine with his wife and two children.

    Comments

    We invite readers to respond with questions or comments. Comments may be held for moderation and will be published according to our comment policy. Comments are the opinions of their authors; they do not represent the views or opinions of Money Under 36.

    1. March says:

      The 2019 contribution numbers went up to $6000 and $7000 for over 50.

    2. April says:

      I’m contributing 9% to my company’s 401k, with 6% matching of $.50 to each $1. I rolled over my old employee’s 401k into an IRA, and then from there I’ll take $1000 per year from my IRA into my ROTH IRA. I’m just not sure how much taxes i can afford if I transfer more than $1000/year. I’m in a high income tax bracket where they take 40% outta my paycheck!!! I own a condo and a house, but things are tight. I’m hoping I’m covering my ass-ets! 28y/o female. no kids. single. $80k/yr before taxes.

    3. Ryan says:

      Roth IRA. For one, I don’t make enough to require a tax break right now. For two, as our nations deficit expands, the need to collect more taxes from citizens is going to have to make its way to the top of the solution pile someday. When that day comes, I’ll be drawing Roth IRA contributions tax free.

    4. I know it all says:

      The biggest perk for a Roth IRA is the growth potential! This thing has unlimited growth, and if you are lucky to have that growth, you won’t have to pay any taxes when you withdraw.

      It is also good for emergency fund as principal (contributions) that you put it is never taxed at any time when you take it out.

    5. Live for Improvement says:

      Roth IRA, because Suze Orman says so. lol

    6. DoneToZen says:

      Roth IRA because it’s important to diversify between tax-free and taxable retirement accounts. I already max out my (traditional) 401K account, so I already have a (bigger) source of taxable income in retirement. If my company offered Roth 401K, then I would contribute to a traditional IRA.

    7. Becca says:

      I’m going with the Roth. I’m 24, so I’ve got a long time to contribute, and thus my earnings will be a larger chunk of my retirement savings than will be my contributions. Getting taxed on just the contributions instead of the whole pot just makes sense.

    8. T says:

      Roth. For tax reasons given here; not at all b/c plan to use as emergency fund.

      (Married, 30yo, one kid on the way, 75k/y combined income before taxes)

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