Roth vs Traditional IRA. Which one is right for you?

2023.07.30

by: The Savy Desi Team

Individual Retirement Accounts (IRAs) are popular retirement savings vehicles that offer tax advantages. Two common types of IRAs are Roth IRA and Traditional IRA. Understanding the differences between these two options is crucial in making an informed decision about your retirement planning. In this article, we will explore the pros and cons of both Roth and Traditional IRAs to help you determine which one aligns better with your financial goals.

Here are some of the Pros of Roth IRA

  1. Tax-Free Withdrawals: One significant advantage of a Roth IRA is that qualified withdrawals are tax-free. Since contributions are made with after-tax dollars, you won’t owe any taxes on the principal or earnings when you withdraw them during retirement.
  2. Flexible Contributions: With a Roth IRA, you can contribute at any age as long as you have earned income. This flexibility allows you to continue saving for retirement even if you work beyond the traditional retirement age.
  3. No Required Minimum Distributions (RMDs): Roth IRAs do not have RMDs during your lifetime, meaning you can let your investments grow tax-free for as long as you wish. This is particularly beneficial if you don’t need to tap into your retirement savings immediately.

Cons for Roth IRA

  1. No Upfront Tax Deductions: Unlike Traditional IRAs, Roth IRA contributions are not tax-deductible. This means you cannot lower your taxable income in the year you make contributions, potentially resulting in higher tax liabilities.
  2. Income Restrictions: High-income earners may be ineligible to contribute to a Roth IRA or face contribution limits. The ability to contribute phases out as your income surpasses certain thresholds, limiting the benefits for wealthier individuals.
  3. Conversion Taxes: If you have a Traditional IRA and wish to convert it to a Roth IRA, you will owe taxes on the amount converted. This tax liability can be substantial, depending on the size of your pre-tax retirement savings.

Now moving on to Pros for Traditional IRA

  1. Tax Deductible Contributions: One of the primary advantages of a Traditional IRA is that contributions are tax-deductible in the year they are made, potentially reducing your taxable income and lowering your current tax bill.
  2. Potential Tax Savings: By deferring taxes until retirement, you may be in a lower tax bracket, resulting in reduced tax liabilities when you withdraw funds.
  3. Access to Penalty-Free Withdrawals: Traditional IRAs offer penalty-free withdrawals for certain specific purposes, such as higher education expenses or first-time home purchases.

Cons for Traditional IRA

  1. Taxable Distributions: Unlike Roth IRAs, withdrawals from Traditional IRAs during retirement are subject to income tax. This can impact your retirement income and potentially increase your tax burden.
  2. Required Minimum Distributions (RMDs): Traditional IRAs require you to start taking RMDs after reaching age 72. These distributions are subject to income tax, and failure to comply with RMD rules can lead to penalties.
  3. Limited Contribution Age: Traditional IRAs have an age limit for contributions. You cannot contribute after reaching age 72, even if you have earned income.

Choosing between a Roth IRA and Traditional IRA depends on your individual circumstances and long-term financial goals. Roth IRAs provide tax-free withdrawals, flexibility, and no RMDs, but contributions are not tax-deductible. Traditional IRAs offer upfront tax deductions, potential tax savings, and penalty-free withdrawals for certain purposes, but distributions are taxable, and RMDs are mandatory.

Consider factors such as your current tax situation, future tax expectations, and income eligibility when making a decision. Additionally, consulting with a financial advisor can provide personalized guidance based on your unique financial situation. Remember, the key is to start saving for retirement early and consistently, regardless of which type of IRA you choose.

Helpful links

  • https://shorturl.at/pAEGL (Bank Rate) – provides calculators to get estimates about how much you can retire with