This guide breaks down the key differences between Traditional and Roth IRAs, helping you understand their benefits, tax rules, and contribution limits. Whether you’re choosing one or combining both, you'll gain insights to make informed decisions for your retirement savings strategy.
Traditional IRA vs. Roth IRA
Retirement planning is crucial for financial security in your later years, and understanding the differences between Traditional and Roth IRAs can help you make informed decisions about your retirement savings strategy. The choice between Traditional and Roth IRAs impacts millions of retirement savers each year. This guide will help you navigate the key differences, benefits, and considerations to determine which IRA suits your financial goals.
Many Americans feel uncertain about the best retirement savings approach. According to Vanguard's 2024 "How America Saves" report, 72% of Americans feel uncertain about which option best suits their financial future. The choice between a Traditional or a Roth IRA depends on your current financial situation and future tax expectations. Some investors even use both to balance tax advantages over time.
Traditional IRA: Save Now, Pay Taxes Later
A Traditional IRA allows you to contribute pre-tax income, reducing your taxable income today while deferring tax obligations until retirement when you may be in a lower tax bracket.
Key Benefits of a Traditional IRA
Traditional IRAs provide immediate tax breaks with the potential for tax-deductible contributions, allowing your savings to grow tax-deferred until retirement. Here are the key tax benefits:
- Immediate Tax Breaks: Contributions to a Traditional IRA are made with pre-tax dollars, which can lower your current taxable income. If your contributions are deductible, you could fall into a lower tax bracket.
- Tax-Deferred Growth: Your investments grow tax-deferred, meaning you won't pay taxes on earnings until you withdraw them in retirement. This allows your money to compound faster, maximizing your potential growth.
- Pay Taxes Later: No need to worry about taxes as you save, you'll owe them when you withdraw funds in retirement
Withdrawals from a Traditional IRA
When you withdraw funds from a Traditional IRA, the money is taxed as ordinary income. Key points to remember:
- Withdrawal Age: You can start making withdrawals without penalties at age 59½. Before this age, early withdrawals may incur a 10% penalty in addition to regular income taxes.
- Required Minimum Distributions (RMDs): Once you reach age 73 (or 75, depending on your birth year), you're required to start taking minimum withdrawals each year. Failing to do so can result in significant tax penalties.
- Impact on Retirement Income: Since withdrawals are taxed as regular income, it’s important to plan your withdrawals based on your expected tax bracket in retirement. This will help you control your taxes and maximize your retirement income.
Eligibility and Contribution Limits
Traditional IRAs have no income limits for contributions — you can contribute regardless of how much you earn. However, whether your contributions are tax-deductible depends on your income and whether you (or your spouse) have a workplace retirement plan.
Annual Contribution Limits (2025):
- $7,000 per year or
- $8,000 per year if you’re 50+ (catch-up contribution)
Tax Deduction Limits Based on Income
If you have a workplace retirement plan, your ability to deduct Traditional IRA contributions from your taxable income depends on your Modified Adjusted Gross Income (MAGI) and tax filing status.
Note: Modified Adjusted Gross Income or (MAGI) is your income after subtracting certain allowed deductions and penalties. Learn more about MAGI here.
If You're Covered by a Workplace Retirement Plan:
- Single Filers:
- Full Deduction: Available if your MAGI is $77,000 or less.
- Partial Deduction: Available if your MAGI is between $77,000 and $87,000.
- No Deduction: If your MAGI exceeds $87,000.
- Married Filing Jointly:
- Full Deduction: Available if your combined MAGI is $123,000 or less.
- Partial Deduction: Available if your MAGI is between $123,000 and $143,000.
- No Deduction: If your MAGI exceeds $143,000.
If You're Not Covered by a Workplace Retirement Plan:
- Single Filers and Married Filing Jointly: You can deduct the full amount of your contribution, regardless of your income.
If You're Not Covered but Your Spouse Is:
- Married Filing Jointly:
- Full Deduction: Available if your combined MAGI is $230,000 or less.
- Partial Deduction: Available if your MAGI is between $230,000 and $240,000.
- No Deduction: If your MAGI exceeds $240,000.
Now that we’ve covered Traditional IRAs, let’s turn our attention to Roth IRAs. This account offers a different approach to your retirement savings.
Be Retirement Confident.
Roll over all your old 401(k)s into a PensionBee Individual Retirement Account (IRA). It takes just a few minutes to sign up.
Get startedRoth IRA: Pay Taxes Now, Enjoy Tax-Free Withdrawals
Roth IRAs take a different approach – contributions are made with after-tax income, allowing tax-free growth and withdrawals in retirement. Income limits apply, so eligibility to contribute depends on your earnings.
Key Benefits of a Roth IRA
Roth IRAs offer unique tax advantages that could benefit you in retirement.
- Tax-Free Growth: Your investments grow without being taxed, which could boost your savings over time.
- Tax-Free Withdrawals: When you take qualified withdrawals in retirement, they are completely tax-free, allowing you to keep all your money and provides a potentially more predictable income stream.
Withdrawals from a Roth IRA
Withdrawals from a Roth IRA have specific rules that make them flexible:
- Qualified Withdrawals: You can take tax-free withdrawals on your earnings if you're at least 59½ and have had the account for at least five years (starting from January 1st of the year of your first contribution to the Roth IRA). Meeting these conditions ensures that your earnings are also tax-free.
- Contributions Withdrawals: You can withdraw your contributions at any time without penalties or taxes since you’ve already paid taxes on that money. This flexibility can be beneficial for managing your finances.
- No Required Minimum Distributions (RMDs): Unlike a Traditional IRA, Roth IRAs don't have required minimum distributions (RMDs), which means you aren’t forced to withdraw money at a certain age. This allows your savings to keep growing tax-free for as long as you want.
Eligibility and Contribution Limits
To contribute to a Roth IRA in 2025, your income must be below a certain limit. The IRS sets these limits based on your Modified Adjusted Gross Income (MAGI) and tax filing status.
Note: Modified Adjusted Gross Income or (MAGI) is your income after subtracting certain allowed deductions and penalties. Learn more about MAGI here.
Annual Contribution Limits:
- $7,000 per year or
- $8,000 if you’re 50+ (catch-up contribution)
Income Limits for Contributions:
- Single Filers:
- Full Contribution: If your MAGI is under $150,000
- Phase-Out: If your MAGI is between $150,000 and $165,000
- Ineligibility: If your MAGI is $165,000 or more
- Married Filers (Joint):
- Full Contribution: If your MAGI is under $236,000
- Phase-Out: If your MAGI is between $236,000 and $246,000
- Ineligibility: If your MAGI is $246,000 or more
Learn more about this year's updated contribution limits here.
Which IRA Could Be Right for You?
Choosing between a Roth IRA and a Traditional IRA can feel like a big decision, but it really comes down to your current income, tax situation, and retirement goals. By understanding the benefits and tax implications of each, you can make the right choice for your future based on your expected tax bracket in retirement. If you're unsure, you can have both!
Traditional IRA
Who It's Suitable For:
- Ideal for individuals who expect to be in a lower tax bracket in retirement.
- There are no income limits for contributions, making it accessible to a wide range of earners.
- Provides an immediate tax deduction, which can significantly reduce your current taxable income.
- Withdrawals in retirement are taxed as ordinary income, which may benefit those looking to lower their taxable income now while anticipating a lower rate later.
- Suitable for individuals focused on maximizing tax savings in their current financial situation.
Who Might Want to Think Twice:
- Those who expect to be in a higher tax bracket in retirement, as withdrawals are taxed as ordinary income.
- Individuals seeking tax-free withdrawals in retirement for greater flexibility.
- If you want to leave money to your loved ones without them owing taxes on it, a Traditional IRA might not be the best choice since withdrawals are taxed.
Roth IRA
Who It's Suitable For:
- Ideal for individuals who expect to be in a higher tax bracket in retirement.
- Provides tax-free withdrawals in retirement, allowing for greater flexibility and financial planning.
- Contributions can be withdrawn at any time without penalties, making it a good option for those who want access to their funds.
- Allows for tax-free withdrawals for beneficiaries, making it a favorable choice for estate planning.
Who Might Want to Think Twice:
- Those currently in a high tax bracket, as paying taxes now on contributions or rollovers could be costly.
- Individuals who need access to their funds soon, since Roth IRA earnings require a five-year holding period for tax-free withdrawals.
- People who are close to retirement and may not have enough time to see the long-term benefits outweigh the immediate tax cost.
Using Both Accounts for a Balanced Strategy
While each IRA has its own unique perks, using both a Traditional and Roth IRA together can really boost your retirement strategy. This combination gives you a wider range of benefits and adds flexibility to how you manage your withdrawals and tax situation. By taking advantage of both accounts, you can potentially create a retirement plan that feels more tailored to your needs, helping you navigate your financial journey as your goals and circumstances change over time.
If you can contribute $7,000 this year ($8,000 if you're 50 or older), you can split it between a Traditional and a Roth IRA, but the total must stay within the limit .
Here’s how you can make the most of each account for withdrawals starting at age 59½:
- In Low-Income Years: Consider withdrawing from your Traditional IRA to take advantage of a lower tax bracket. Since Traditional IRA withdrawals are taxed as ordinary income, taking money out when your income is lower can help reduce your overall tax burden.
- In High-Income Years: Consider using your tax-free Roth IRA withdrawals to avoid pushing yourself into a higher tax bracket
- Contributions Strategy: You don’t need to split your contributions evenly between both IRAs. Consider your current tax situation, income, and retirement goals.
- For example, you could put $4,000 in your Traditional IRA for tax benefits and $3,000 in your Roth IRA for tax-free growth.
This balanced approach could offer the best of both worlds. Additionally, contributing to both IRAs provides several benefits:
- Tax Diversification: This strategy helps manage your tax burden in retirement, allowing you to choose the most tax-advantageous option for withdrawals.
- Flexibility in Withdrawals: Having both accounts enables you to adapt your withdrawal strategy based on your income and tax situation.
- Immediate Tax Benefits and Future Tax-Free Growth: Enjoy immediate tax deductions from the Traditional IRA while benefiting from tax-free growth in the Roth IRA.
- Hedging Against Future Tax Increases: This approach can protect you against potential future tax rate hikes by providing access to tax-free withdrawals from your Roth IRA.
- Estate Planning Advantages: Roth IRAs allow for tax-free inheritance for beneficiaries, optimizing your assets for your heirs.
Despite these advantages, many savers miss out on this strategy — ICI’s (Investment Company Institute) research from 2022 reveals that only 24% of retirement savers currently utilize both accounts for their retirement plan. By combining the two, you can create a retirement strategy that aligns with your goals and offers flexibility as life changes.
Pensionbee Can Help: Traditional, Roth, Or Both!
With PensionBee, you can choose a Traditional IRA for upfront tax savings, a Roth IRA for tax-free withdrawals, or both for greater flexibility. PensionBee simplifies retirement planning by rolling over old 401(k)s into one easy-to-manage account, allowing you to choose one or both options between a Traditional and Roth IRA, so you can better track your retirement savings all from the palm of your hand.
Combine your savings, manage transfers, and stay on track with contributions. Every customer gets a personal rollover manager - we call them BeeKeepers - to help guide you through a simple, stress-free process, so you can feel confident about your retirement.
