Traditional IRAs versus Roth IRAs

Roth IRAs are frequently mentioned in the popular press as one of the top vehicles for retirement saving.  But are they really all they're cracked up to be?

In this week's blog we'll explain the differences between traditional IRAs and Roth IRAs.  Next week we'll dig into the actual math to examine which vehicle is "best".

Currently, there are two popular Individual Retirement Accounts (IRAs) vying for your attention: the traditional IRA and the Roth IRA. While both are long-term savings vehicles with tax benefits, each has different rules concerning contributions, age, and income that may change from one year to the next.


Perhaps the biggest difference between traditional IRAs and Roth IRAs is how and when taxes apply to the contributions and earnings. Contributions to traditional IRAs can be pre-tax (deductible on the taxpayer’s income tax return). Although contributions and earnings accumulate on a tax-deferred basis, income taxes are due when IRA distributions are taken and become penalty free after age 59 ½.

On the other hand, contributions to Roth IRAs are made with after-tax dollars, and  contributions and earnings accumulate tax free. No income tax or penalty is due when distributions are taken from a Roth IRA after age 59 ½ and meet the 5-year rule.

For tax year 2021, the combined maximum contribution to a traditional IRA or Roth IRA is $6,000 ($7,000 for individuals age 50 or older).

Age Restrictions

Contributions to traditional IRAs may be made at any age. Required minimum distributions (RMDs) must begin by April 1 of the year after an individual reaches age 72 (or a considerable tax penalty may apply). Roth IRAs have neither an age limit for contributions
nor minimum distribution requirements. However, both traditional and Roth IRAs have a minimum age for distributions: 59½. Distributions taken prior to age 59½ may be subject to a 10% Federal income tax penalty (there are several exceptions to this penalty).

Certain situations qualify as exceptions to the penalty, such as distributions to pay first-time-homebuyer expenses or qualified education expenses. Furthermore, before tax-free distributions can be received from the appreciation of a Roth IRA, the account must be five years old.

Income Eligibility Limits

Depending on your tax-filing status, your income, and your participation, or lack thereof, in a qualified employer-sponsored retirement plan, you may be eligible to take an income tax deduction for contributions to a traditional IRA. If you are a single taxpayer, do not participate in a qualified employer sponsored plan, and earn a minimum of $6,000, contributions are deductible regardless of your adjusted gross income (AGI). However, if you do participate in an employer-sponsored retirement plan, income limitations apply. Deductions in 2021 phase out for single filers with modified AGIs (MAGIs) between $66,000 and $76,000, and for married couple joint filers with MAGIs between $105,000 and $125,000.

The income eligibility requirements are different for Roth IRAs. If you participate in a  qualified employer sponsored retirement plan, you may contribute to a Roth IRA; however, if you are also contributing to a traditional IRA, your contributions may not exceed the
annual contribution limits. You are eligible to make a full contribution to a Roth IRA if your MAGI in 2021 does not exceed $125,000 for single filers or $198,000 for married joint filers (contributions phase out for single filers with MAGIs between $125,000 and $140,000, and for married joint filers with MAGIs between $198,000 and $208,000). For a married individual, filing separately, who participates in a workplace retirement plan, the phase-out range is $1 to $10,000.

A Roth IRA is often a favored choice for those who participate in a qualified employer-sponsored retirement plan and exceed the income limits for a deductible IRA, but meet the income eligibility requirements for a Roth IRA.

Analyze This

As you investigate which IRA – or combination of IRAs – is right for you, consider the following questions:
• What tax benefits, current and long-term, are available to you?
• When do you anticipate needing your IRA proceeds?

As we will see in next week's post, the future direction of tax rates also plays a role in determining which vehicle may be best.

Where to Turn For Help

We've been helping clients prepare for, and thrive in retirement for over three decades.  Our clients' continued financial success is exceeded only by their success at the game of life.

When we build retiree portfolios at Oxford, we seek a balance between Stability and Growth following the principles outlined in our proprietary Power of 5 Investing system. Our goal is to help clients achieve inflation-beating growth in their wealth, while managing through market downturns, ultimately helping clients leave a legacy to the people and places they love.  Our system has been battle tested in 25+ years of market ups and downs and is ready for whatever the market can throw at it.

The evaluation of Roth IRAs vs. traditional IRAs can be complex, often requiring a familiarity with the tax code and even the use of financial software to sort things out.  If you find yourself struggling, you're not alone.  Click on the button below to schedule a free Get Acquainted meeting to see how we might help.