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Traditional vs. Roth IRA: How to Choose the Right Plan

January 25, 2021 · 8 minute read

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Traditional vs. Roth IRA: How to Choose the Right Plan

For many Americans, employer-sponsored plans like the 401(k) are the primary vehicle for retirement savings. These programs allow individuals to automatically defer a certain percentage of each paycheck directly into an investment account, and in most cases you’ll also get a tax break since those wages won’t count toward your taxable income in the year you earn them.

But for those who don’t have access to an employer-sponsored plan, or who simply want to up their retirement savings game by stashing away as much cash as possible, an IRA—or individual retirement account—may be a solution. These accounts allow you to make retirement contributions with special tax benefits, even if you’re self-employed.

Overview of Traditional and Roth IRA Plans

The two most common types of IRA are the traditional IRA and the Roth IRA. It’s helpful to understand the difference between Roth and traditional IRA options when saving for retirement.

Traditional IRAs are funded with pre-tax dollars, while a Roth IRA is funded with after-tax contributions. The same annual contribution limits apply to both types of IRAs, including catch-up contributions for savers aged 50 and older. For 2021, the regular contribution limit is $6,000, with an additional $1,000 allowed in catch-up contributions.

Whether it makes sense to open a traditional vs. Roth IRA can depend on eligibility and the types of tax advantages you’re seeking. With Roth IRAs, for example, you get the benefit of tax-free distributions in retirement but only taxpayers within certain income limits are eligible to open one of these accounts. Traditional IRAs, on the other hand, offer tax-deductible contributions, with fewer eligibility requirements.

In weighing which is better, traditional or Roth IRA plans, it’s important to consider what you need each plan to do for you. Opening a Roth IRA vs. regular IRA can allow you to save money for retirement and invest it in a variety of ways. But you may find one type of tax break (i.e. tax-deductible contributions vs. tax-free distributions) more valuable than another.

The Differences Between Traditional vs. Roth IRAs

When choosing which type of retirement account to open, it’s helpful to fully understand the difference between Roth and traditional IRA options. Specifically, that means knowing:

•  Eligibility rules for making contributions to a Roth or traditional IRA
•  Tax treatment of both IRA contributions and IRA withdrawals, including early withdrawal penalties
•  Required minimum distribution requirements

The IRS has specific guidelines governing who can contribute to an IRA, the amount of contributions you can make, and how you’ll pay taxes on the money you save for your retirement. Navigating the rules can seem confusing, so it’s helpful to look at each guideline individually to get a sense of whether a Roth or traditional IRA is the better fit.

We’ll get into the key differences for these rules below.

Traditional vs. Roth IRA Eligibility

Anyone below age 72 who earns taxable income can open a traditional IRA.

Roth IRAs have no such age restriction—individuals can make contributions at any age as long as they have income for the year.

Roth IRAs, however, have a key restriction that a traditional IRA does not: An individual must earn below a certain income limit to be able to contribute. In 2021, that limit was $125,000 for single people (people earning more than $125,000 but less than $140,000 can contribute a reduced amount). For those individuals who are married and file taxes jointly, the limit is $198,000 to make a full contribution and $208,000 for a reduced amount.

The ceilings are based on modified adjusted gross income, which is basically the adjusted gross income listed on one’s tax return with certain deductions added back in.

SoFi’s Roth IRA calculator lets individuals plug in income and other factors, to see which account they can contribute to and how much they can put in.

Traditional IRA Taxes vs. Roth IRA Taxes

With a traditional IRA, individuals can deduct the money they’ve put in (aka contributions) on their tax returns, which lowers their taxable income in the year they invest. Come retirement, investors will pay income taxes at their ordinary income tax rate when they withdraw funds. This is called tax deferral. For individuals who expect to be in a lower tax bracket upon retirement, a traditional IRA might be preferable.

The amount of contributions a person can deduct depends on their adjusted gross income (AGI), tax filing status, and whether they have a retirement plan through their employer. This chart, based on information from the IRS , illustrates the deductibility of traditional contributions for the 2020 tax year.

Filing Status If You ARE Covered by a Retirement Plan at Work If You ARE NOT Covered by a Plan at Work
Single or Head of Household You can deduct up to the full contribution limit if your modified AGI is $65,000 or less. You can deduct up to the full contribution limit, regardless of income.
Married Filing Jointly You can deduct up to the full contribution limit if your AGI is $104,000 or less. You can deduct up to the full contribution limit, regardless of income, if your spouse is also not covered by a plan at work.

If your spouse is covered by a plan at work, you can deduct up to the full contribution limit if your combined modified AGI is $196,000 or less.
Married Filing Separately You’re allowed a partial deduction if your modified AGI is less than $10,000. You’re allowed a partial deduction if your modified AGI is less than $10,000.

With a Roth IRA, on the other hand, contributions aren’t tax-deductible. But investors won’t pay any taxes when they withdraw money they’ve contributed at retirement, or when they withdraw earnings, as long as they’re at least 59.5 years old and have had the account for at least five years.

For people who expect to be in the same tax bracket or a higher one upon retirement—for example, because of high earnings from a business, investments, or continued work—a Roth IRA might be the more appealing choice.

Here’s a side-by side-comparison of traditional vs. Roth IRA benefits and characteristics.

   Roth IRA Traditional IRA
Annual Contribution Limits (2020 Tax Year) $6,000, plus an additional $1,000 in catch-up contributions if you’re 50 or older $6,000, plus an additional $1,000 in catch-up contributions if you’re 50 or older
Tax-Deductible Contributions? No Yes, based on income, filing status and whether you’re covered by a retirement plan at work
Early Withdrawal Penalties Contributions can be withdrawn penalty-free at any time; early withdrawals of earnings may be subject to a 10% penalty and ordinary income tax Early withdrawals of contributions earnings may be subject to a 10% penalty and ordinary income tax
Good for… Individuals who are income-eligible and want the benefit of tax-free withdrawals in retirement Individuals who want an upfront tax break in the form of deductible contributions

Roth IRA vs. Traditional IRA Rules & Regulations

It’s important to understand how the IRS regulates Roth vs. regular IRAs. These rules exist to ensure that investors don’t unfairly benefit from tax breaks when using an IRA as part of their financial plan.

Specifically, the IRS regulates who can make contributions to IRAs, in what amount, and how those contributions can be withdrawn. There are also guidelines concerning when IRA distributions are mandatory. Becoming familiar with the regulations surrounding these accounts is another key step when weighing whether a traditional vs. Roth IRA makes more sense for you.

Contributions to Roth vs. Traditional IRAs

Contributions are the same for both Roth and traditional IRAs. The IRS effectively levels the playing field for individuals saving for retirement by setting the same maximum contribution limit across the board.

For the 2021 tax year the IRA contribution limit is $6,000, with an extra $1000 contribution for those age 50 or older. Individuals have until the April tax filing deadline to make IRA contributions for the current tax year. To fund an IRA for the 2020 tax year, investors have until the April 2021 tax filing deadline to do so.

With a Roth IRA, investors can continue making new contributions into their account, regardless of age. That might appeal to an investor who plans to delay retirement past the traditional age of 65 or 66 and continue working. As long as a person has income for the year, they can keep adding money to their Roth account.

Traditional IRAs, on the other hand, don’t allow individuals to make contributions indefinitely. As long as a person is working, they can make contributions—but only up to age 72. After that, they can no longer continue putting money into their account.

Withdrawals from Roth vs. Traditional IRAs

Generally with IRAs, the idea is to leave the money untouched until retirement. The IRS has set up the tax incentives in such a way that promotes this strategy. That said, it is possible to withdraw money from an IRA before retirement.

With a Roth IRA, an individual can withdraw the money they’ve contributed (not counting any money earned in appreciation) at any time. They can also withdraw up to $10,000 in the earnings they’ve made on investing that money without paying penalties as long as they’re using the money to pay for a first home (under certain conditions).

With a traditional IRA, an investor will generally pay a 10% penalty tax if they take out funds before age 59.5. There are some exceptions to this rule, as well.

These are the IRS exceptions for early withdrawal penalties:
Disability or death of the IRA owner. In this case, disability means “total and permanent disability of the participant/IRA owner.”

Qualified higher education expenses for you, a spouse, child or grandchild.
Qualified homebuyer. First time homebuyers can withdraw up to $10,000 for a down payment on a home.
Unreimbursed medical expenses. These include health insurance premiums paid while unemployed and expenses greater than 7.5% of your AGI.

Required Minimum Distributions from IRAs

The IRS doesn’t necessarily allow investors to leave money in your IRA indefinitely. Traditional IRAs are subject to required minimum distributions, or RMDs. That means an individual must start taking a certain amount of money from their account (and paying income taxes on it) by April 1 of the year after they reach age 72—whether they need the funds or not. Distributions are based on life expectancy and your account balance.

If an individual doesn’t take a distribution, the government may charge a hefty 50% penalty on the amount they didn’t withdraw.

For those who don’t want to be forced to start withdrawing from their retirement savings at a specific age, a Roth IRA may be preferable. Roth IRAs have no RMDs. That means a person can withdraw the money as needed, without fear of triggering a penalty. Roth IRAs might also be a vehicle for passing on assets to your heirs or beneficiaries, since you can leave them untouched throughout your life and eventual death if you choose to.

   Roth IRA Traditional IRA
Required Minimum Distributions? No Yes, beginning at age 72
Tax Penalty for Missing RMDs N/A 50% of the amount you were required to withdraw

Which IRA Is Right for You?

So which is better, traditional or Roth IRA? A person can have both a Roth IRA and a traditional IRA. But if you’re choosing between them, here’s a recap of the similarities and differences of the Roth vs. traditional IRA.

Roth IRA Traditional IRA
•  Available to those who make below income limits of $125,000 for single filers or $198,000 for married couples filing jointly in 2021
•  Contributions capped at $6,000 per year (or $7,000 per year after age 50)
•  Contributions are taxed immediately, but withdrawn tax-free at retirement
•  Investors can access the funds they’ve put into the account at any time, and investment earnings up to $10,000 without a tax penalty when purchasing a qualified first home
•  No RMDs
•  All earners can contribute, up to $6,000 per year (or $7,000 per year after age 50)
•  Contributions are tax-deferred—investors won’t pay taxes on them until withdrawal in retirement
•  10% tax penalty on early withdrawals (on top of regular income taxes) with certain exceptions
•  Subject to RMDs starting on April 1 after age 72

The Takeaway

For most people, if not all, an IRA can be a great way to bolster retirement savings, even if one is already invested in an employer-sponsored plan like a 401(k).

When it comes to retirement, every cent counts, and starting as early as possible can make a big difference—so it’s always a good idea to figure out which type will work for you sooner than later.

SoFi Invest® offers IRAs (both Traditional and Roth). Find out how our team of financial planners can work with you to create a personalized retirement plan, open an IRA, or rollover an old 401(k) into an IRA.


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