Traditional IRA vs. Roth IRA: What's the difference?

• A traditional IRA is funded by pre-tax income, while Roth IRAs are funded by after-tax dollars.
• Unlike traditional IRAs, contributions made to a Roth IRA aren't tax deductible and distributions aren't taxed.
• For both traditional and Roth IRAs, contributions can be made at any age and savings grow while untaxed.

The two main types of individual retirement accounts, or IRAs, are traditional IRAs and Roth IRAs. These differ from their contribution limits to distribution requirements. However, you don't always have to choose one over the other.

"People assume you only have to have one type of IRA, but that's not the case," says Liz Young, head of investment strategy at SoFi. A Roth IRA may make sense at one point in your life, while a traditional IRA can make sense at another. At times, you'll want to keep both tax-advantaged accounts open.

Find out when each account makes sense for you.

Traditional IRA vs. Roth IRA: At a glance

Traditional IRAs and Roth IRAs vary in their tax advantages and who can contribute to them.

• Traditional IRAs make contributions tax-deductible up to a certain amount, grow savings tax-free, and subject withdrawals to income tax.
• Roth IRAs are available under a certain income threshold, grow savings tax-free, and offer tax-free withdrawals.

The Internal Revenue Service (IRS) limits the amount you can contribute each year to all of your traditional and Roth IRAs. For 2021, that limit is $6,000, or $7,000 if you're 50 years or older.

Quick tip: A Roth IRA is often the better choice. But if your income eventually phases you out of Roth IRA territory, keep your money there and open a traditional IRA, too.

What is a traditional IRA?

A traditional IRA is a retirement account that offers tax-deductible contributions and tax-deferred retirement savings. It's available to all income brackets, although high-income taxpayers may face some drawbacks.

"As your income grows and you start earning more money and [are] pushed into higher tax brackets, a traditional IRA starts to make more sense," says Kathleen Kenealy, Certified Financial Planner and director of financial planning at Boston Private, a Silicon Valley Bank company.

Traditional IRA contributions: You (and your spouse) can make regular contributions to a traditional IRA at any age. You can deduct contributions in full if you and your spouse don't have an employer-sponsored retirement plan. If you or your spouse do, your deduction amount will depend on your income.

Over the years, your money that grows in the account is not subject to taxes during that time.

Traditional IRA withdrawals: Distributions, or withdrawals, from traditional IRAs are taxed according to your tax bracket in retirement.

You must start taking distributions, known as required minimum distributions (RMDs), by April 1 of the year after you turn 72 and by December 31 of later years. Withdrawing money before you turn 59.5 will result in a 10% penalty, with some exceptions.

Quick tip: If you can afford to, delay withdrawals from your traditional IRA as long as you can to keep your money growing for a few extra years.

Example of a Traditional IRA

Let's say you're single and under 50. You don't have access to a 401(k), so you contribute $4,000 to a traditional IRA in 2021. For the 2021 tax year, you can deduct all $4,000.

If you did have a 401(k), your modified adjusted gross income (AGI) would have to be $66,000 or less in 2021 to deduct the full $4,000. If your income was more than $66,000 but less than $76,000, you could deduct a partial amount determined by IRS calculations. A modified AGI of $76,000 disqualifies you from the tax deduction.

What is a Roth IRA?

Roth IRAs offer tax-deferred savings and tax-free withdrawals, making them a smart choice for those who expect higher tax rates in retirement.

Roth IRA contributions: A Roth IRA is available only under income thresholds set by the IRS. If you qualify, you can make contributions to a Roth IRA at any age.

Your money in a Roth IRA will grow over time and is not taxable.

Quick tip: Roth IRAs aren't available to everyone, but experts recommend that if you qualify, you should open and contribute to a Roth IRA.

Roth IRA withdrawals: Roth IRAs offer more flexibility when it comes to taking distributions. You can make withdrawals if you are disabled, once you reach age 59.5, or after five years from the tax year when you made your first contribution. Qualified distributions also include those that are made:

• To a beneficiary or to your estate after your death
• For qualified first home purchases (lifetime limit of $10,000)
• For qualified disasters

Roth IRAs don't impose RMDs, and you can continue contributing during retirement. "This is a useful tool to control your taxable income in retirement and supplement it with tax-free Roth IRA distributions - a move that is quite tactical," suggests Matt Rogers, Certified Financial Planner and director of financial planning at Fidelity's eMoney Advisor.

If you withdraw from a Roth IRA early and don't meet any exceptions, you will face a 10% tax penalty.

Example of a Roth IRA

Let's stick to the traditional IRA example above where you contributed $4,000.

If your modified AGI for 2021 was less than $125,000, you would be left with a $2,000 limit for your total Roth IRA contribution. If you made at least $125,000 but still less than $140,000, your limit would drop to an amount determined by IRS calculations. Making $140,000 or more disqualifies you from contributing to a Roth IRA altogether.

The financial takeaway

If there had to be a winner between the two, it would be a Roth IRA. Its savings grow tax-deferred, distributions are not taxed, and you often don't have to wait until retirement to use the money. Its main downside is that it's not available to everyone - mostly high-income individuals.

Traditional IRAs aren't without their benefits, though. Their savings also grow tax-deferred, and you often get a tax break for contributing to one. Just make sure to keep up with all of its requirements and limitations.