Traditional or Roth IRA, or both?

Traditional and Roth IRAs offer different benefits — but both can make sense.

Key takeaways

  • Taxes are a key consideration in deciding between a Roth IRA and a traditional IRA.
  • It may make sense to contribute to both types of IRAs if you are eligible, so you have tax free and taxable options when you withdraw the money in retirement.

You're ready to save for retirement in an IRA. But wait; there are two types of IRAs — a traditional IRA and a Roth IRA. Which one should you choose? You may be able to contribute to both types. Here are some things to keep in mind as you decide which is the appropriate choice for you now.

First, the basics. Traditional and Roth IRAs are types of tax-advantaged accounts designed to help people save for retirement. For 2017 and 2018, eligible taxpayers can contribute up to $5,500 (or up to the level of earned income, if lower) to a traditional IRA, or $6,500 if they have reached age 50.

The same goes for a Roth IRA, as long as your income is not above the limits (the ability to contribute to a Roth IRA starts to phase out at $186,000 for 2017 and $189,000 in 2018, if you are married and file a joint return. If you are a single filer, the phase-out begins at $118,000 in 2017 and $120,000 in 2018). That may seem like a substantial sum of money to save for a distant goal like retirement, but the benefits such as a potential federal income tax deduction if you're eligible and tax-deferred or tax-free growth may make saving for retirement seem a little easier.

Which kind of IRA?

With a traditional IRA, your contribution may reduce your taxable income and, in turn, your federal income taxes if you are eligible for the tax deduction.1 Earnings can grow tax deferred until withdrawn, although if you make withdrawals before age 59½, you may incur both ordinary income taxes and a 10 percent penalty. (There are a handful of situations that may qualify for waiving the early withdrawal penalty. Read Viewpoints on How to take an early withdrawal from your IRA.) Starting in the year you reach age 70½, you will need to begin taking required minimum distributions (RMDs) and paying ordinary income taxes on the distribution amount.

To estimate your tax savings on a traditional IRA contribution, you'll need your marginal tax rate. Get your rate with our tax-rate chart. Then multiply it by the amount of money you contributed to your traditional IRA. That's generally how much a traditional IRA may reduce your federal income tax. (Keep in mind that it's an estimate. In some cases your contribution can reduce your marginal tax rate, so your federal tax savings might be smaller. On the other hand, you might also save on state income taxes.) For instance, a person with a 25 percent marginal federal income tax rate would save $1,375 in taxes on a contribution of $5,500.

With a Roth IRA, your contribution isn't tax deductible the year you make it, but your money can grow tax free and your withdrawals are tax-free in retirement, provided that certain conditions are met.2 Contributions to a Roth IRA are subject to income limits.3 and earnings on those contributions (although not the contributions themselves) may be subject to both tax and early withdrawal penalties if withdrawn before the qualifying criteria are met.3 Unlike traditional IRAs, Roth IRAs do not have RMDs (during the original owner's life).

Also, if your spouse doesn't work, they can have a spousal IRA. This allows non-wage-earning spouses to contribute to their own traditional or Roth IRA, provided the other spouse is working and the couple files a joint federal income tax return. This means eligible married spouses can each contribute up to $5,500 each tax year to their respective IRAs.4 Spousal IRAs are also eligible for a $1,000 catch-up contribution for those 50 and older. There is an earned income requirement to contribute to an IRA. You, or your spouse, must have taxable income at least up to your contribution amount(s).

You can have both IRAs (traditional and/or Roth) in addition to workplace retirement savings plans like 401(k) or 403(b) plans. However, a traditional IRA contribution may not be fully tax deductible if you and/or your spouse are covered by a workplace plan.1 You can contribute to a Roth IRA, even if you have contributed to your workplace plan, as long as you meet the income eligibility requirements.3

Making a decision

Should you contribute to a traditional or Roth IRA, or both? For many people, the answer comes down to a simple question: Do you think you'll be better off paying taxes now or later?

If you expect your tax rate in retirement to be higher than your current rate, a Roth IRA's tax-free withdrawals might make it the better choice. That's because withdrawals from a traditional IRA are taxable, and if your tax rates are higher in retirement than when you made the contribution, you will pay higher taxes on the money.

But tax rates don't tell the whole story. "How disciplined you are at saving can also play a role in which type of account may better help you prepare for retirement," explains Matthew Kenigsberg, vice president of financial solutions at Fidelity. Here's why. Generally, pretax contributions to a traditional IRA can help lower your taxable income, if you are eligible, giving you more money in your pocket. These tax savings help improve your retirement picture only if you're disciplined enough to save. If you tend to spend any money left at the end of the month, or any income tax refund, it's not going to help your bottom line when you retire.

With Roth IRA contributions, you pay taxes up front. But if you (like many people) tend to spend all your discretionary income, having less disposable income might be a good thing when it comes to your retirement savings. "In a sense," says Kenigsberg, "switching from a traditional IRA to a Roth IRA forces you to save more for later by keeping less in your pocket now, assuming you keep making the same contribution."

Roth IRAs have additional advantages that go beyond taxes. Because you don't need to take RMDs with a Roth (during the life of the original owner) and because the assets in a Roth account can be bequeathed to your heirs income-tax free, it can be a useful estate-planning tool. (Read Viewpoints on 9 compelling reasons to consider a Roth IRA)

Not eligible to contribute to a Roth IRA because your income is too high? You can convert a traditional IRA to a Roth IRA, though you will need to pay taxes on the conversion. (If you've made nonqualified contributions and include them in your converted balance, they won't be taxed.) For a detailed look at tax-smart conversion strategies, read Viewpoints on Tax-savvy Roth IRA conversions.

Having it both ways

It may be appropriate to contribute to both a traditional and a Roth IRA — if you can. Doing so will give you taxable and tax-free withdrawal options in retirement. Financial planners call this tax diversification, and it's generally a smart strategy when you're unsure what your tax picture will look like in retirement. (Remember, though, you can contribute only $5,500, or $6,500 if you are age 50 or older, in total to any traditional and Roth IRAs you have in any one year.)

For example, with a combination of traditional and Roth IRA savings, you could take distributions from your traditional IRA until you reach the top of your income tax bracket, and then withdraw whatever you need beyond that amount from a Roth IRA, which is tax free, provided certain conditions are met. For more on tax-efficient IRA withdrawal strategies, read Viewpoints on 4 tax-efficient strategies in retirement.

On the other hand, taxes in retirement may not be the whole story. Reducing your current taxable income through traditional IRA contributions may also be advantageous for other reasons, such as qualifying for student financial aid. Read Viewpoints on A guide for student loans.

Investing an IRA contribution

Many people make their IRA contribution just before the April tax deadline, and put it into a money market fund. Then they never go back and choose a growth-oriented investment. This is generally not ideal. One of the best ways to give the money a chance to grow over the long term is by having an age-appropriate level of diversified exposure to stocks — in the form of mutual funds, ETFs, or individual securities. Of course, that means getting used to riding the ups and downs of the market.

Consider this: One $5,500 contribution could grow to almost $59,000 in 35 years. For those age 50 or older, one $6,500 yearly contribution could grow to more than $69,000 in 35 years.5 We used a hypothetical 7 percent long-term compounded annual rate of return and assumed the money stays invested the entire time. Investments that have the potential to return 7 percent annually are generally those that come with some risk, such as stocks.

If the $5,500 amount seems daunting, even if you can put only $550 into an IRA and leave it there invested for 35 years, earning a hypothetical annual return of 7 percent, it could be worth $5,872 in 35 years. Make that $550 contribution every year and it could be worth $81,352 after 35 years, using a hypothetical annual rate of return of 7 percent. (Note: These examples do not take into account taxes, inflation, or fees.)

This information is intended to be educational and is not tailored to the investment needs of any specific investor.

  1. For a Traditional IRA, full deductibility of a contribution for 2017 is available to active participants whose 2017 Modified Adjusted Gross Income (MAGI) is $99,000 or less (joint) and $62,000 or less (single); partial deductibility for MAGI up to $119,000 (joint) and $72,000 (single). In addition, full deductibility of a contribution is available for working or nonworking spouses who are not covered by an employer-sponsored plan whose MAGI is less than $186,000 for 2017; partial deductibility for MAGI up to $196,000. For 2018 full deductibility of a contribution is available to active participants whose 2018 Modified Adjusted Gross Income (MAGI) is $101,000 or less (joint) and $63,000 or less (single); partial deductibility for MAGI up to $121,000 (joint) and $73,000 (single). In addition, full deductibility of a contribution is available for working or nonworking spouses who are not covered by an employer-sponsored plan whose MAGI is less than $189,000 for 2018 partial deductibility for MAGI up to $199,000.

  2. A distribution from a Roth IRA is tax free and penalty free, provided the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, disability, qualified first-time home purchase, or death.

  3. For 2017, if you're single, or file as head of household, the ability to contribute to a Roth begins to phase out at MAGI of $118,000, and is phased out completely at $133,000. If you're married filing jointly, the corresponding numbers are $186,000 and $196,000, respectively.
    For tax year 2018, if you're single or file as head of household, the ability to contribute to a Roth IRA begins to phase out at MAGI of $120,000 and is completely phased out at $135,000. If you're married filing jointly, the phase-out range is $189,000 to $199,000.

  4. Note that the contribution limit applies to the sum of the contributions to both types of IRA for each spouse. So for each spouse, the maximum contribution limit for a traditional IRA is reduced by any amount contributed to a Roth IRA for the same year, and vice versa.

  5. The hypothetical examples assume the following: one annual $5,500 or $6,500, IRA contribution made on January 1 of the first year, a 7 percent annual rate of return, and no taxes on any earnings within the IRA. The ending values do not reflect taxes, fees, or inflation. If they did, amounts would be lower. Earnings and pretax (deductible) contributions from a traditional IRA are subject to taxes when withdrawn. Earnings distributed from Roth IRAs are income tax free provided certain requirements are met. IRA distributions before age 59½ may also be subject to a 10 percent penalty. Systematic investing does not ensure a profit and does not protect against loss in a declining market. Consider your current and anticipated investment horizon when making an investment decision, as the examples may not reflect this. The assumed rate of return used in this example is not guaranteed. Investments that have potential for a 7 percent annual rate of return also come with risk of loss.

Find helpful guidance, tools, and services to assist you as you prepare for retirement on your terms. See more Fidelity Retirement Viewpoints.

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