Is a Roth IRA Better Than a Traditional IRA?

The primary difference between a Roth and Traditional IRA are the tax benefits. A Roth IRA allows you to contribute to the account with dollars that have already been taxed. However, once you get to retirement, you can make withdrawals from your Roth tax free.

A Traditional IRA is just the opposite. You make contributions to the account with pre-tax dollars, and defer your tax until retirement at which point the dollars in your Traditional IRA are taxed as income when you take a withdrawal. Contributions to a Traditional IRA can also be tax deductible depending on your income and if you have a retirement plan through work.

To put it simply, you pay taxes up front when using a Roth IRA, but get tax benefits when you take withdrawals in retirement. You get tax benefits up front when you use a Traditional IRA, but will pay taxes when you take withdrawals in retirement.

The IRS determines who qualifies for a Roth or Traditional IRA so it is important to check your eligibility before opening one of these accounts.

In general, anyone with earned income can qualify for a Traditional IRA. Anyone with earned income whose modified adjusted gross income is below set levels can qualify for a Roth IRA. What does this mean? Essentially, if you want to have a Roth IRA, the IRS dictates that your income cannot exceed a certain level.

If you want to make the max contribution to a Roth IRA in 2023, your modified adjusted gross income has to be $218,000 or less if you are married filing jointly, or $138,000 or less if you are filing as an individual.

Since IRAs provide tax benefits, the IRS puts a cap on the amount you can contibute to both a Roth or Traditional IRA. For 2023, you can contribute up to $6,500 per year, or $7,500 per year if you are over 50. You can contribute this amount to either a Roth or Traditional IRA, or a combination of the two, but your annual contributions cannot exceed the amounts listed above.

Now lets take a look at the withdrawal rules for an each account. For a Traditional IRA, you can start taking withdrawals at age 59 and 1/2 at which point your withdrawals will be taxed as ordinary income. If you take a withdrawal before age 59 and 1/2 you can be subject to an additional 10% penalty.

There are certain exceptions in which you will not incur this 10% penalty. Since you are deferring your tax bill until retirement, Traditional IRAs are also subject to required minimum distributions (RMDs). Since the IRS wants to tax the money in your Traditional IRA, you are required to start taking withdrawals from your Traditional IRA at age 73 beginning in 2023.

Roth IRA withdrawal rules are slightly different. You can withdraw the base amount of your contributions at any time since you have already paid tax on those dollars. However, if you want to withdraw any of your earnings, there are a few more rules.

If you want to have tax free withdrawals of your earnings you must be at least 59 and 1/2 and your Roth IRA must be at least 5 years old. If you try to take a withdrawal outside of these rules, you can incur a 10% penalty as well as taxes. Similar to the Traditional IRA, there are certain withdrawal expections in which you can avoid the 10% penalty, but not the taxes.

Many financial experts are leaning towards the Roth IRA being better than the Traditional IRA. The reason? Taxes. If taxes go up in the futures, the Roth IRA becomes a significantly more attractive option. However, you should also consider the following before making a choice.

1) Eligibility: This is pretty cut and dry. You either qualify for a Roth IRA or you don't. If you don't qualify, your only option is to open up a Traditional IRA, or get around the eligibility requirements by using a back door Roth IRA.

2) Taxes: As we have noted throughout this post, the primary difference between a Roth and Traditional IRA is the way the accounts approach taxes. If taxes are lower in the future, it would make sense to defer your tax today using a Traditional IRA, and pay a lower tax rate later.

However, if taxes are higher in the future, it would make more sense to pay taxes today, and then enjoy tax free withdrawals in retirement. Although it is impossible to perfectly predict the future, we recommend speaking with a tax professional to help you figure out if it makes more sense to defer your tax bill, or pay taxes today.

There are many places that you can open a Roth or Traditional IRA. Our first recommendation is to use a robo advisor. Almost all robo advisors offer both Roth and Traditional IRAs. Beyond that, a robo advisor will build you a complete investment portfolio that aligns with both your risk tolerance and overall investing goals. You can check out our post on the top robo advisors of 2023 to learn more.

If you want more control of the investments that are placed in your Roth or Traditional IRA, you can opt to open your account through an online broker. An online broker will allow you to buy a range of investments within your Roth or Traditional IRA commission free. If neither of these options work for you, there are some investing apps that also offer access to IRAs.