I will be discussing the 2 types of IRAs, Traditiional IRAs and Roth IRAs. I will also touch base on the benefits, the differences and the facts about both types of IRAs.
The Basics
IRA stands for Individual Retirement Account, which is an investment account individuals use for saving for retirement and the accounts have special restrictions and tax rules to constrain the use of the accounts for your later (e.g retirement) years of life.
As of June 30, 2023, there was $13.9 Trillion invested in IRAs with about $9.3T in Traditional IRAs and $4.6T in Roth IRAs.1
What is ROTH IRA vs Traditional IRA?
A Roth IRA is an Individual Retirement Account to which you contribute after-tax dollars. Unlike Traditional IRA, Roth IRA contributions will not reduce your prior year tax bill. However, your contributions and earnings grow tax-free.
You can withdraw your Roth IRA contributions tax-free anytime.
Earnings can be withdrawn penalty free, if both criterias are met:
1. The Roth IRA account itself must be open for at least five years.
2. You must be at least 59½ years old when you make the withdrawal.
A Roth IRA can be a good savings option for those who expect to be in a higher tax bracket in the future, making tax-free withdrawals even more advantageous.
Roth IRA Benefits:
• You can contribute at any age, if you have a qualifying earned income.
• Contributions and potential investment gains accumulate tax-free.
• Withdrawals can be taken out tax-free and penalty free, provided your age 59½ or older and you have met the minimum account holding period (currently five years).
• There is no need to take required minimum distributions with a Roth IRA.
• If you pass your Roth IRA onto your heirs, their withdrawals will also be income tax-free.
However, there are income limitations to opening a Roth IRA, so not everyone will be eligible for this type of retirement account. The earnings limits and phaseouts change annually and depend on your filing status and if one or both spouses have an employer plan, like a 401(k). Seek advice on this to get quick answers from your tax professional about your unique situation.
What is a Traditional IRA?
A Traditional IRA is an account to which you can contribute pre-tax (aka “never taxed”) dollars or you may also contribute after-tax dollars -- in cases where your income disqualifies you from making pre-tax contributions. Your contributions may be tax deductible depending on your situation, helping to reduce immediate taxes in the current tax year.
With a Traditional IRA, your money can grow tax deferred.
When you’re ready to spend your Traditional IRA savings, you pay ordinary income tax on your pre-tax withdrawals.
You may prefer never to make withdrawals; however, tax rules require that you must take distributions after age 73 (For some who turn 72 in 2022 or before the RMD age is 72). Unlike with a Roth IRA, there are no income limitations to opening a Traditional IRA. It may be a good option for those who expect to be in the same or lower tax bracket in the future.
Some good benefits that Traditional IRA will do with your retirement:
• This may be a good option for those who expect to be in the same or lower tax bracket in the future, as you'll pay ordinary income tax on your withdrawals.
• No income limitations to opening an account
• Depending on your income level or if you don't have an employer-sponsored retirement plan, your contribution may be fully deductible.
Roth IRA vs. Traditional IRA
| Category | Roth IRA | Traditional IRA |
| Income eligibility | May contribute if MAGI does not exceed income limitations. Must have U.S. earned income. | No income limit restrictions on contributions. Must have U.S. earned income. |
| Age restrictionsNone | None | None |
| Tax deductibility | Contributions are never deductible. | You may be eligible to deduct all or a portion of your contributions, depending on various factors. |
| Withdrawal of contributions | Withdraw anytime without taxes or penalties. | Withdraw anytime, but deductible contributions are taxable and subject to penalties if withdrawn before age 59 ½, except for hardship withdrawals. |
| Withdrawal of earnings | Tax and penalty-free if a qualified withdrawal. Qualified distributions are tax-free if certain conditions are met. | Taxable when withdrawn and subject to penalties if withdrawn before age 59 ½, except for hardship withdrawals. |
| Required minimum distributions (RMDs) | None during your lifetime. | RMDs required starting at a certain age. |
| Contribution limits | Contribution limits for 2022 and 2023 based on age and income. | Contribution limits for 2022 and 2023 based on age. |
| Contribution deadline | Your tax return filing deadline (not including extensions). | Your tax return filing deadline (not including extensions). |
Employees can have both 401 (k) and any IRAs. IRAs make a great supplement to retirement savings, especially if you’re contributing enough to receive a full match from your employer, or you’re planning on maxing out your 401(k). That really depends on contributions made annually and age.
The big differences are 1. 401k contribution limits are the highest and are pre-tax. In 2023 the limit is:
• The IRS sets a maximum limit on contributions made to 401(k) plans by an individual and their employer every year.
• The 2023 401(k) contribution limit is $22,500 for people under 50.
• The 2024 401(k) contribution limit is $23,000 for people under 50.
The annual contribution limit for an IRA in 2023 is $6,500; $7,500 for those 50 and up. In 2024, the IRA contribution limit rises to $7,000, or $8,000 if you’re 50 or older. And you can make contributions to an IRA for 2023 until April 15, 2024.
For your reference: Roth IRA vs. Traditional IRA | Compare IRAs | T. Rowe Price (troweprice.com)