Roth vs. Traditional IRA: Which One Makes More Sense?

What’s the difference between a Roth and traditional IRA? When does a Roth IRA make sense? Can I have both? TD Ameritrade can help you decide.

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Key Takeaways

  • Understand the differences between a Roth and traditional IRA
  • An IRA can play a role in your financial plan even if you have an employer-sponsored retirement plan
  • Choosing a Roth vs. traditional IRA could come down to your eligibility and financial situation

Making retirement investment decisions can be a conundrum. You want to spend the money you earn, but at the same time you want to save enough for retirement. And once you’ve come to terms with putting aside money for retirement, there are so many choices—traditional IRA, Roth IRA, backdoor Roth IRA, etc. But you’re not limited to one choice. You may have access to an employer-sponsored retirement plan, but you can still consider investing in an Individual Retirement Account (IRA) to supplement contributions to your employer’s plan. And if you don’t have an employer-sponsored plan, an IRA can be the primary way to invest for retirement.

Either way, an IRA may be a great way to invest for retirement and potentially reduce your taxes. IRAs fall under two main categoriestraditional and Roth. The decision to invest in a Roth versus traditional IRA is a personal one and will depend on many factors, including your eligibility and financial situation.

Traditional IRA vs. Roth IRA: How to Choose

A good starting point would be to understand the similarities and differences between Roth and traditional IRAs. The contribution limits for traditional and Roth IRAs are the same: $6,000 (2020 and 2021), plus an additional $1,000 if you’re age 50 or older. And they have the same deadline: You have until April 15, 2021, to make a 2020 contribution.

However, traditional and Roth IRAs offer different features and potential tax benefits, which may make one more appealing to you than the other.

Traditional IRARoth IRA
Age Limit for Contributions
  • None for 2020 as a result of changes made by the SECURE Act
  • None
Income Requirements
  • Earned income should be equal to or more than contribution amount, though there are some income limits
  • For example, if you contribute $1,000 you must have income of least that much
  • 2020: Contributions phased out if income is $124,000–$139,000 for individuals ($196,000–$206,000 for joint filers)
  • 2021: Contributions phased out if income is $125,000–$140,000 for individuals ($198,000–$208,000 for joint filers)
Potential Tax Benefits
  • Tax-deductible contributions
  • Tax-deferred investment earnings
  • Tax-free qualified withdrawals
Withdrawals
  • Taxable as ordinary income
  • 10% penalty if you take money out before age 59 1/2, unless an exception applies
  • If you are age 59.5, you can withdraw earnings and contributions without tax or penalty provided the account has been open for five or more years
  • Contributions can be withdrawn from an IRA at any time. Earnings may be subject to 10% penalty and taxable.
Required Minimum Distributions
  • None for 2020; generally starting at age 72
  • RMDs will be required for 2021
  • No
This table provides a high-level overview of traditional versus Roth IRAs. It’s not comprehensive. Additional requirements or restrictions may apply. TD Ameritrade does not provide tax advice. We suggest you consult with a tax-planning professional with regard to your personal circumstances.

You Don’t Have to Pick Just One

Your decision between a traditional versus Roth may ultimately come down to whether you expect your income tax rate to be higher or lower in retirement. For example, if you think your tax rate will be higher, you may decide to contribute to a Roth IRA and pay taxes now at your current rate. During retirement, any qualified distributions would be tax-free regardless of your tax bracket. On the other hand, if you think you’ll be in a lower tax bracket in retirement, you may want to a consider a traditional IRA and pay taxes later when you take the money out.

Because no one knows for certain what the future holds, you may want to consider having both a traditional and Roth IRA. This approach may help you create a withdrawal strategy in retirement that aims to minimize taxes and keeps more of your money working for you. Note: Between both accounts, you can’t contribute more than $6,000 ($7,000 for age 50+) for any one year. You should also be aware of the Roth income limits.

When Does a Roth IRA Make Sense?

If you already have a traditional IRA and want to potentially reduce your tax bill in retirement, you could consider converting (transferring) some or all of your account to a Roth IRA. You may also want to consider a conversion if your income is too high to contribute to a Roth directly. However, before proceeding you’ll want to make sure you have enough funds to cover taxes. Any money you transfer could be subject to tax at the time of conversion. Plus, any Roth conversions can no longer be “recharacterized,” which means they can’t be transferred back to a traditional IRA if you change your mind about the conversion.

Traditional or Roth?

The choice is yours. Traditional and Roth IRAs are both great ways to invest for retirement and can offer solid benefits. The type you choose should align with your goals and financial situation. Still not sure which one that is? Check out IRA tools and resources to help you decide. The most important thing is to get started and take control of your retirement.

All investing involves risks including loss of principal.

Maximum contribution limits cannot be exceeded. Contribution limits provided are based on federal law as stated in the Internal Revenue Code. Applicable state law may be different. TD Ameritrade does not provide legal or tax advice. Please consult your legal or tax advisor before contributing to your IRA.

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Key Takeaways

  • Understand the differences between a Roth and traditional IRA
  • An IRA can play a role in your financial plan even if you have an employer-sponsored retirement plan
  • Choosing a Roth vs. traditional IRA could come down to your eligibility and financial situation

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