Roth vs. Traditional IRA: Which Is Right for You?

Planning on saving for your golden years with an individual retirement account (IRA)? If so, the first step is understanding and deciding between a Roth versus a traditional IRA. Although all IRAs operate as retirement savings accounts, both differ in several critical aspects. 

In this guide, we’ll explore Roth and traditional IRAs, including IRA contribution limits, IRA rules, and tax benefits. We’ll also discuss how Composer’s automated trading tools can enhance retirement savings and help you reach your investing goals.

What’s the difference between a traditional IRA and a Roth IRA?

The primary differences between Roth and traditional IRAs lie in their tax treatment and withdrawal limits. You can determine which account is better for you by evaluating these differences in reference to your current income and retirement goals.

Roth IRA

Roth IRAs accept after-tax contributions, meaning you don’t get a tax deduction on contributions. Instead, investments in a Roth IRA grow tax-free, so you don’t pay taxes on qualified withdrawals (including contributions and earnings) in retirement. 

Unlike traditional IRAs, Roth IRAs do not have RMDs during the original owner’s lifetime. This extended timeline provides more flexibility in managing your investments and estate planning. 

You can withdraw your Roth IRA contributions at any time, penalty- and tax-free. In contrast, you can only withdraw earnings tax- and penalty-free after age 59 ½ and once you’ve held your account for at least five years. 

Roth IRA contribution limits depend on your income level. Contribution limits phase out at higher incomes, meaning some high-income earners can’t contribute to a Roth IRA at all.

Traditional IRA

Traditional IRAs allow tax-deductible contributions of earned income up front. These contributions do not count toward your reportable income, resulting in a lower tax bill. 

Since traditional IRAs accept pre-tax contributions, withdrawals get taxed at your regular income tax rate. You must take a required minimum distribution (RMD) each year beginning at age 72 (or 73 if you turned 72 after Dec. 31, 2022). The IRS may charge you a 50% penalty based on your RMD amount if you do not take your distribution on time. 

Although you can withdraw funds from your account before 59 ½, early withdrawals may incur taxes and a 10% early withdrawal penalty. Certain exceptions allow early withdrawals without a penalty, such as buying your first house, paying for higher education, or paying off medical debt.   

Contribution limits and rules

Although Roth and traditional IRA limits are the same, they can vary yearly based on IRS guidelines. In 2024, the maximum contribution limit is as follows:

• $7,000 for individuals under 50

• $8,000 for individuals 50 and older

You can only contribute earned income to a traditional or Roth IRA. Earned income includes wages, salaries, tips, and commissions but excludes dividend interest, child support, Social Security payments, and alimony.

Although traditional and Roth IRAs have the same baseline contribution limits, they are subject to different rules.

Traditional IRA deduction rules

You can contribute to a traditional IRA regardless of your income level. If you don’t have a 401(k) or other work-related retirement plan, you can deduct all traditional IRA contributions from your federal income tax return. However, if you or your spouse also have a retirement plan through an employer, the amount you can deduct from IRA contributions varies depending on your modified adjusted gross income (MAGI).

These are the 2024 deduction limits for IRA holders who also have a retirement plan at work:

• Married filing jointly or qualifying widow(er)

  • MAGI of $123,000 or less: Full deduction

  • Between $123,000 and $143,000: Partial deduction

  • $143,000 or more: No deduction

• Single or head of household

  • MAGI of $77,000 or less: Full deduction

  • Between $77,000 and $87,000: Partial deduction

  • $87,000 or more: No deduction

If you don’t have a retirement plan through your employer but your spouse does, these are the 2024 deduction limits:

• Married filing jointly

  • MAGI of $230,000 or less: Full deduction

  • Between $230,000 and $240,000: Partial deduction

  • $240,000 or more: No deduction

• Married filing separately

  • MAGI less than $10,000: Partial deduction

  •  $10,000 or more: No deduction

Roth IRA contribution rules

Unlike traditional IRAs, your annual contribution limit for a Roth IRA depends on your income. The limit decreases once you earn above a certain MAGI and eventually hits $0, making you ineligible to contribute.

In 2024, the income limits are as follows:

• Married filing jointly or qualifying widow(er)

  • MAGI less than $230,000: Full contribution

  • Between $230,000 and $240,000: Partial contribution

  • Greater than $240,000: Ineligible for contribution

• Married filing separately

  • MAGI between $0 and $10,000: Partial contribution

  • Greater than $10,000: Ineligible for contribution

• Single or head of household

  • MAGI less than $146,000: Full contribution

  • Between $146,000 and $161,000: Partial contribution

  • Greater than $161,000: Ineligible for contribution

Withdrawal rules

Although you can take distributions from your IRA anytime, they may incur taxes and penalties depending on your account type and age. IRA transfers and rollovers do not incur penalties or taxes, but you may need to report these movements to the IRS. 

Traditional IRA withdrawal rules

Withdrawals from a traditional IRA before age 59 ½ incur income taxes and a 10% early withdrawal penalty. After 59 ½, you can withdraw funds penalty-free, although you must still pay regular income tax on distributions. You can withdraw funds early without a penalty if you use the money for certain expenses, such as medical debt, student loan interest, or purchasing your first home.

Beginning at age 72 (or 73, depending on your birth date), you must take RMDs each year. The RMD amount is calculated by dividing your IRA account balance on Dec. 31 of the previous year by your life expectancy. Failing to take your RMD on time may result in a 50% penalty based on your RMD amount.

Roth IRA withdrawal rules

You can withdraw contributions from a Roth IRA anytime without penalty or taxes. To withdraw earnings tax-free, you must wait until you are 59 ½ and have held your account for at least five years. Known as the five-year rule, this applies regardless of your age, meaning you could be 59 ½ or 100 before you can withdraw earnings tax-free, depending on the date you made your first contribution. 

Unlike traditional IRAs, Roth IRAs do not have RMDs, meaning you don’t need to withdraw any money from your Roth IRA at any point in your life. This rule does not apply to Roth IRA beneficiaries, excluding a spouse designated as sole beneficiary. 

Tax benefits

Both traditional and Roth IRAs provide unique tax benefits. These benefits make IRAs excellent vehicles for generating retirement wealth. 

Traditional IRA tax benefits

You can deduct traditional IRA contributions from your federal and state tax returns, lowering your reportable income in the year you make the contributions. Lower reportable income results in lower regular income taxes for that year.

Since traditional IRAs only accept pre-tax contributions, you must pay income tax on withdrawals. Although this sounds like a disadvantage, traditional IRA distributions often get taxed at a lower income tax bracket, as most retired individuals report relatively little taxable income.

Roth IRA tax benefits

Roth IRA taxes work differently from a traditional IRA. You can only contribute after-tax money to a Roth IRA, meaning you can’t deduct contributions from your reportable income. In exchange, you can withdraw contributions anytime tax-free, and earnings become tax-free after you reach age 59 ½ and have held your account for at least five years. 

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