Common financial wisdom tells us that as a paid member of the American workforce, you should contribute the maximum to your 401(k), 403(b), 457(b) or similar retirement plan, especially if your organization matches a percentage of your contributions. But not every company has one of these plans. As an individual taxpayer with earned income, you have other options available to you in order to save for retirement, including the IRA or “Individual Retirement Account.” But there are two types: Roth and traditional. What are the differences?
An IRA is a type of account which acts as a shell or holder. Within the IRA, you can invest in many different types of assets—you have far more choices than your company 401(k)’s short list of fund options. You can choose between CDs, government bonds, mutual funds, ETFs, stocks, annuities—almost any type of investment available. You can open an IRA account at a bank, brokerage, mutual fund company, insurance company, or some may be opened directly online.
The question is, should you open your IRA as a traditional IRA or a Roth IRA? Your decision should be based on your income as well as your current and future tax situation, because both Roth IRAs and traditional IRAs are qualified retirement accounts subject to different IRS rules.
Here’s a basic overview of how a Roth compares to a traditional IRA:
Post-Tax versus Pre-Tax Dollars
The biggest difference between Roth versus traditional IRA retirement accounts is that Roth IRA contributions are made with post-tax dollars, while traditional IRA contributions are typically made with pre-tax dollars. You have until the individual federal tax deadline, usually April 15, to open or contribute to either type of IRA and have it count toward the previous tax year on your tax returns.
Ordinary Income Tax versus Tax-Free
When you begin taking money out of these two types of accounts for retirement, traditional IRA distributions are treated as ordinary income and taxed accordingly, while Roth IRA distributions are usually taken out tax-free, because you already paid income taxes on the money before you invested it. Essentially, with a Roth IRA, your interest, dividends and capital gains which accumulate inside it are tax-free as long as you follow all Roth IRA withdrawal rules.
Roth Income Restrictions
Roth IRAs have income restrictions that may disqualify higher-income people from participating; traditional IRAs do not. For instance, in order to contribute to a Roth IRA for 2025, single tax filers must have a modified adjusted gross income (MAGI) of less than $150,000 while the MAGI limit for joint married filers is $236,000 to make a full contribution amount of $7,000, or $8,000 for those age 50 or older.
These income limits can change over time, so it’s important to check the current IRS guidelines to determine eligibility for making Roth contributions.
Same Annual Contribution Amounts
The annual maximum contribution limits for both traditional IRAs and Roth IRAs are the same. For 2025, you can contribute up to $7,000 depending on your income, plus an additional $1,000 catch-up contribution if you reach age 50 by the end of the tax year. If married, you can contribute up to that amount for yourself in your own IRA, plus up to that amount in a separate IRA for your non-working or low-earning spouse subject to certain restrictions. If you are eligible to contribute to both types of IRAs, you may divide your contributions between a Roth and traditional IRA. However, your total contribution to both IRAs must not exceed the total limit for that tax year (including the catch-up contribution if you’re age 50 or over).
Traditional IRA Contributions Are Tax-Deductible for Some People
Roth IRA contributions are not deductible on your taxes, but contributions to a traditional IRA may be deductible on federal and state tax returns, lowering your taxable income for the year, depending on your tax status, your income, and whether or not you or your spouse contributes to a plan through work such as a 401(k). If your income is low enough and you follow all IRS rules, your contribution to a traditional IRA may qualify for a tax credit, accounted for on your tax return in the year you choose to make the contribution. You have until the individual federal tax deadline, usually April 15, to do so.
RMDs Not Required from Roth IRA Accounts
Roth IRA accounts are not subject to annual RMDs, or Required Minimum Distributions, which are required annually (and taxes due) for traditional IRA accounts starting at age 73.
Roth Conversions
You can convert a traditional IRA to a Roth IRA, but strict rules apply. And be careful, because you have to pay income taxes on the money converted, and recent tax law changes mean you can’t undo this later. Doing this over a period of years can save some people a lot of money in taxes during retirement for the long-term, and can be left to heirs tax-free as well. NOTE: High earners may consider a “Backdoor Roth” conversion, but it is advisable to work with financial and accounting experts when doing so, as they require strict adherence to many rules.
Withdrawals from Roth IRAs versus traditional IRAs:
- Roth IRA withdrawals:
When it comes to withdrawing money, you can withdraw your Roth IRA contributions—the money you’ve put in—at any time, at any age with no penalty as long as the account has been in place for five years, so your Roth IRA can double as your emergency fund.
However, if you withdraw Roth IRA earnings prior to reaching age 59-1/2, you may have to pay income taxes on them, with some exceptions, such as first-time homebuyer expenses. Qualified education and hardship withdrawals may also be available before the age limit and without the five-year waiting period, but you may have to pay income tax on any amount that was attributed to earnings.
Remember, with a Roth IRA, there are no RMDs. If you don’t need the money, you’re not required to withdraw any money from your Roth IRA at all, and it can pass to your heirs tax-free if the account was established at least five years before inheritance. But they can’t leave it in the Roth account—they will have to withdraw all the money and close the account within 10 years.
- Traditional IRA withdrawals:
Traditional IRA withdrawals come with a 10% tax penalty before age 59-1/2, plus ordinary income taxes will be due on all amounts withdrawn.
Certain exceptions to the tax penalty on early withdrawals may apply, including hardship, health care, disability or higher education expenses, or to make a down payment on your first home. NOTE: Although there may not be a penalty, you will still have to pay income taxes on the withdrawal.
With traditional IRAs, annual RMDs must start at age 73 whether you need the money or not, and you have to pay ordinary income tax on the amounts withdrawn each tax year. There is no grace period to tax day; you must withdraw the money each year by midnight on December 31 or pay a 10 to 25% penalty plus taxes owed.
It is important to understand that beneficiaries of inherited traditional IRA accounts are generally required to take annual RMDs, and to withdraw the entire account balance within 10 years of the original owner’s passing and pay taxes on those distributions. These required withdrawals and associated taxes can potentially push heirs into a higher tax bracket, resulting in significant tax consequences.
Side note: Beneficiary designations on accounts such as 401(k)s, 403(b)s, 457(b)s, traditional IRAs, Roth IRAs, and insurance policies override instructions in your will or estate documents. Therefore, it is critical to regularly review and update your beneficiary designations to ensure they reflect your current wishes.
If you have any questions about this information or want to review or update your retirement plan, we can help. Contact us!
This article is for informational purposes only and is not intended to provide any individual with tax or financial advice. We encourage you to consult with your tax professional, financial advisor or attorney to discuss your personal situation. It’s also important to keep in mind that Congress can change the rules regarding these accounts at any time. The regulations may be very different when you retire.
Sources:
https://www.irs.gov/newsroom/401k-limit-increases-to-23500-for-2025-ira-limit-remains-7000
https://investor.vanguard.com/investor-resources-education/iras/roth-ira-income-limits
https://www.fidelity.com/retirement-ira/inherited-ira-rmd
https://investor.vanguard.com/investor-resources-education/retirement/rmd-rules-for-inherited-iras
