Traditional IRA vs. Roth IRA: Which One Works for You?
Published on November 17, 2017
Comparing Traditional IRA and Roth IRA’s
If you don’t have access to a retirement plan through your employer, you’ll want to consider opening your own account to stash away money for the future. And even if you do have a 401(k), you might want to save more than the max you can put into it.
In either case, that’s where IRAs—or individual retirement accounts—come in. But IRAs come in different flavors, and it can be confusing to figure out which one you need.
The basics of both IRA plans
The two main types of IRAs are Traditional and Roth IRAs. They have certain things in common: They let you save money for retirement and invest it in a variety of ways, while potentially taking advantage of tax benefits. You can contribute as long as you’re earning income (or your spouse is), even if you work part-time. And you’re limited to contributing a certain amount each year (in 2017, the ceiling was $5,500 for those under 50).
But they also have important differences, specifically about when and how you might get tax breaks. Your choice can have a big impact on how much money you can keep in your pocket today compared to when you retire. The accounts also differ on who is eligible to contribute and for how long, as well as when you can take distributions.
The good news? You don’t need a crystal ball to get a good sense of which account option is right for you. Here’s what to consider:
Am I eligible for a Traditional IRA or a Roth IRA?
Anyone who gets taxable income can open a Traditional IRA, with one exception: You can no longer make regular contributions when you reach the age of 70.5. (Who knew half-birthdays actually mattered?) For a Roth IRA, you can make contributions at any age.
Roth IRAs have a key restriction: You must earn below a certain income limit to be able to contribute. In 2017, that limit was $118,000 for single people (though, if you earn below $133,000, you can contribute a reduced amount). For those who were married and filed taxes jointly, the limit was $186,000 to make a full contribution or $196,000 for a reduced amount. The ceilings are based on modified adjusted gross income, which is basically the adjusted gross income listed on your tax return with certain deductions added back in.
SoFi’s IRA calculator lets you plug in your income and other factors and can help you figure out which account you can contribute to and how much you can put in.
When does my IRA get taxed?
With a Traditional IRA, you can deduct the money you’ve put in (a.k.a. your contributions) on your tax return, which lowers your taxable income today. Instead, you will pay income taxes when you withdraw funds in retirement.
With a Roth IRA, your contributions aren’t tax-deductible. But you won’t pay any taxes when you withdraw money you’ve contributed, or when you withdraw earnings if you’re at least 59.5 years old and have had the account for at least five years.
What does this mean for you? In general, you should go with a Traditional IRA if you think you’ll be in a lower tax bracket after you retire. If you think you’ll be in the same tax bracket or a higher one—for example, if you expect to have high earnings from a business, investments, or continued work—go for a Roth IRA if you’re eligible.
Another way to think about it: If you typically get a tax refund, go with a Roth IRA—you don’t need any more tax breaks right now. If you typically owe a lot in taxes, consider a Traditional IRA to get the tax benefit today.
Can I withdraw money from my IRA before I retire?
Generally, you should leave the money in your IRA untouched so it’s there for you when you’re counting on it. But if you’re reluctant to contribute because you’re afraid your cash will be locked up should you need it, that’s not always the case.
With a Roth IRA, you can withdraw the money you’ve put in any time without paying penalties or taxes. You can also withdraw up to $10,000 in the earnings you’ve made on investing that money without paying penalties to help pay for your first home under certain conditions. With a Traditional IRA, you will generally pay a 10% penalty tax if you take out funds before you’re 59.5 (there go those half-birthdays again). There are some exceptions, including for qualified educational or medical expenses, but in any case, you’ll want to be careful and discuss any potential early withdrawals with a tax professional first.
When do I have to start taking money out of my IRA?
With Traditional IRAs, you will be subject to required minimum distributions. That means you need to start taking a certain amount of money out of your account (and paying income taxes on it) by April 1 of the year after you reach age 70.5—whether you need the funds or not. If you don’t take a distribution, the government will charge a 50% penalty on the amount you didn’t withdraw. Taking distributions will add to your income and could put you in a higher tax bracket. If you don’t ever want to be forced to start withdrawing from your retirement savings, then a Roth IRA may be a better option.
Still confused about whether a Traditional or Roth IRA is right for you? A SoFi financial advisor can help you decide. Set up your personalized IRA consultation—absolutely free.
SoFi Wealth, LLC does not render tax or legal advice. Individual circumstances are unique and we recommend that you consult with a qualified tax advisor for your specific needs.
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