When it comes to retirement planning, IRAs (Individual Retirement Accounts) are some of the most powerful tools at your disposal. But not all IRAs are created equal. The choice between a Roth IRA and a Traditional IRA isn’t just a financial decision—it’s a bet on your future circumstances, tax bracket, and retirement strategy.
In this post, I’ll break down the key differences between Roth and Traditional IRAs and how they might fit into your portfolio strategy.
Roth IRA vs. Traditional IRA
Let’s start with the core distinction: taxes.
- Traditional IRA: You contribute pre-tax dollars (or, for some people, post-tax dollars if you exceed the income limit for tax-deductible contributions). This means you save on taxes today, but withdrawals during retirement are taxed as ordinary income.
- Roth IRA: Contributions are made with after-tax dollars, so there’s no immediate tax benefit. However, qualified withdrawals in retirement are completely tax-free, including any growth in your investments.
Eligibility: Income and Limits
- Traditional IRA: Anyone with earned income can contribute, but the tax deductibility of contributions phases out at higher income levels if you or your spouse participate in a workplace retirement plan.
- Roth IRA: Your eligibility phases out entirely at higher income levels. In 2024, Roth contribution limits begin to phase out at $150,000 for single filers and $236,000 for married couples filing jointly.
Both accounts share the same annual contribution limit—$7,000 for 2025, or $8,000 if you’re 50 or older.
IRA Withdrawal Rules
- Traditional IRA: Withdrawals before age 59½ are subject to a 10% penalty plus taxes. At age 73 (starting in 2023), Required Minimum Distributions (RMDs) force you to start withdrawing funds, whether you need them or not.
- Roth IRA: Contributions can be withdrawn at any time without taxes or penalties. Earnings can also be withdrawn tax-free if you meet the age (59½) and 5-year holding requirements. Plus, Roth IRAs have no RMDs, giving you more flexibility in retirement planning.
The Tax Question: Pay Now or Pay Later?
The decision often boils down to whether you expect to be in a higher or lower tax bracket in retirement:
- If you think your tax rate will be higher in retirement, a Roth IRA can save you money by locking in today’s lower tax rate.
- If you think your tax rate will be lower in retirement, a Traditional IRA lets you defer taxes, giving you immediate savings and potentially paying less overall.
Here’s an example:
- Imagine you’re 30 years old, earning $60,000 annually and contributing $7,000 a year to an IRA. If you choose a Roth IRA, you pay taxes on the $7,000 now but won’t owe taxes on the potentially six-figure balance at retirement. If you choose a Traditional IRA, you save on taxes today but will owe taxes on the withdrawals later.
Blending Strategies: Why Not Both?
There’s no rule saying you can only choose one. A blended strategy might make sense, especially if you’re unsure about future tax rates. For instance:
- Max out your Roth IRA to take advantage of its tax-free growth and flexibility.
- Contribute to a Traditional IRA (or a workplace 401(k)) to reduce taxable income and hedge against future tax uncertainty.
- Withdraw from both over time, to control your taxable income in retirement.
Final Thoughts
The choice between a Roth and Traditional IRA isn’t a one-size-fits-all decision, there is no right or wrong here. It’s about understanding your current financial situation, predicting your future needs, and diversifying your tax exposure for retirement. Your retirement portfolio is one of the most important assets you’ll ever own. Choosing the right tools to build it can make all the difference.
For more information, check out the IRS website.
Want to calculate how your IRA contributions could grow over time? Check out our Future Value of Investments Calculator here on PortfolioLiteracy.com!