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Traditional and Roth IRAs both offer tax breaks, but not at the same time—here's how they differ
Younger investors will likely benefit more from a Roth IRA than a traditional IRA. We explain why.
The easiest way to start saving for retirement is through an IRA, but which type of account you choose can make a big difference in just how much money you'll receive when you're no longer working.
Traditional IRAs and Roth IRAs are the two most popular types of retirement accounts, but they have considerable differences that any investor should take into account before choosing which to open.
With traditional IRAs, you delay paying any taxes until you withdraw funds from your account later in retirement. With Roth IRAs, however, you pay taxes upfront by contributing after-tax dollars and later in retirement your withdrawals are tax-free (as long as your account has been open for at least five years).
Generally, traditional IRAs are most effective if you expect to be in a lower tax bracket when you retire, while Roth IRAs are best for those in a lower tax bracket today. The latter is most likely better for younger investors who are early on in their careers and thus planning to have more income (and a higher tax rate) when they retire.
Beyond just tax implications, however, there is more to consider when choosing between a traditional IRA and a Roth IRA.
From their rules around withdrawing early, to their contribution limits and their eligibility requirements, Select breaks down what the two types of retirement accounts have in common and where they differentiate. Plus, we recommend our top picks of each.
The benefits of contributing to an IRA
IRAs stand out as an effective way to save for retirement because of the tax breaks we mention above, but that's not their only benefit. One of the biggest perks of an IRA (both traditional and Roth) is that they offer tax-free growth on your investments, so you won't be taxed on dividends or capital gains while the investments are in your account.
IRAs are easy to set up and accessible, offered at most banks and credit unions, as well as through online brokers and investment companies. You can set up automatic contributions into your IRA from your checking or savings account, which makes investing for your future one less thing to think about.
And unlike being limited to your employer's 401(k) plan, you can choose your investments with an IRA and many brokerage firms or banks will help guide you depending on your timeline to retirement.
If you already have a 401(k) plan through your employer, an IRA is an effective way to supplement your retirement savings. And since a 401(k) has the same tax benefits as a traditional IRA, the choice is easy: tagging on a Roth IRA along with your 401(k) will make sure you get a tax break now and in the future.
Early withdrawal rules
Overall, the rules around withdrawing early from an IRA are more lenient with Roth IRAs than with traditional IRAs.
Traditional IRAs: If you withdraw funds from your traditional IRA before age 59 and a half, you are taxed at your current income tax rate and you are charged a 10% early withdrawal penalty fee.
Roth IRAs: Withdrawing from your Roth IRA before age 59 and a half depends on whether it's your contributions or your earnings that you're tapping into. Withdrawing contributions from your Roth IRA at any age is tax- and penalty-free. Withdrawing earnings before age 59 and a half, however, incurs a 10% early withdrawal penalty and may be subject to income taxes like with a traditional IRA.
Roth IRAs also offer a unique perk that traditional IRAs do not: First-time home purchases, college expenses and birth or adoption expenses (up to certain limits) count as exceptions to the early withdrawal penalty.
Traditional IRAs and Roth IRAs have the same contribution limits, which is set each year.
Both traditional and Roth IRAs: For 2021, your total contribution limit to both traditional and Roth IRAs is up to $6,000 if you are under 50, and up to $7,000 if you are 50 or older.
Traditional IRAs also offer a helpful perk that Roth IRAs do not: Your contributions into a traditional IRA can be deducted from your taxes each year, up to certain limits. This essentially means you get rewarded for putting money into your retirement account since the contributions help reduce the amount you owe in taxes. But be careful: Instead of spending those savings each year when you do your taxes, consider reinvesting them back into your retirement account to maximize the amount of money you have available come retirement time. The deduction limits for traditional IRAs in 2021 are as follows:
You cannot make a deduction if ...
- You have a retirement plan at work and your income is $76,000 or more as a single filer/head of household
- You (or your spouse, if married) have a retirement plan at work and your income is $125,000 or more as married filing jointly
- You (or your spouse, if married) have a retirement plan at work and your income is $10,000 or more as married filing separately
If you (and your spouse, if married) do not have a retirement plan at work, you can make a full deduction up to the amount of your contribution limit.
Traditional IRAs and Roth IRAs differ when it comes to who can open an account.
Traditional IRAs: Anyone can contribute regardless of how much money they earn.
Roth IRAs: There are income limits that restrict high-earners from opening and contributing directly to a Roth IRA. The income limits for Roth IRAs in 2021 are as follows:
- Married filing jointly or qualifying widow(er): Not eligible if your modified adjusted gross income is $208,000 or more
- Single, head of household or married filing separately (and you didn't live with your spouse at any time during the year): Not eligible if your modified adjusted gross income is $140,000 or more
- Married filing separately (if you lived with your spouse at any time during the year): Not eligible if your modified adjusted gross income is $10,000 or more
There is a backdoor Roth IRA strategy for those who don't qualify under the income limits — this loophole allows people to make indirect contributions to a Roth IRA.
The best traditional and Roth IRAs for your retirement saving
After you have gone through the commonalities and differences between traditional and Roth IRAs above, it's time to shop around for the best provider of whichever account your choose.
We reviewed and compared over 20 different accounts offered by national banks, investment firms, online brokers and robo-advisors so that you don't have to. While many providers offer both traditional and Roth IRAs, some stand out better for those looking to open a Roth IRA because they are attractive to young investors.
Here are our top-rated picks that offer traditional and Roth IRAs — and have perks that beginners can benefit greatly from, such as no minimum deposits requirement and educational tools to help you in your investing journey.
- Best overall: Charles Schwab
- Best for beginner investors eager to learn: Fidelity Investments
- Best for hands-on beginner investors: Ally Invest
- Best for hands-off beginner investors: Wealthfront
- Best for access to a financial advisor: Betterment
Minimum deposit and balance
Minimum deposit and balance requirements may vary depending on the investment vehicle selected. No account minimum for active investing through Schwab One® Brokerage Account. Automated investing through Schwab Intelligent Portfolios® requires a $5,000 minimum deposit
Fees may vary depending on the investment vehicle selected. Schwab One® Brokerage Account has no account fees, $0 commission fees for stock and ETF trades, $0 transaction fees for over 4,000 mutual funds and a $0.65 fee per options contract
Robo-advisor: Schwab Intelligent Portfolios® and Schwab Intelligent Portfolios Premium™ IRA: Charles Schwab Traditional, Roth, Rollover, Inherited and Custodial IRAs; plus, a Personal Choice Retirement Account® (PCRA) Brokerage and trading: Schwab One® Brokerage Account, Brokerage Account + Specialized Platforms and Support for Trading, Schwab Global Account™ and Schwab Organization Account
Stocks, bonds, mutual funds, CDs and ETFs
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This article has been updated to show that account holders don't pay taxes on growth (capital gains or dividends) while the money is in the account, in either a Roth or traditional IRA. You must pay taxes, however, on any withdrawals from a traditional IRA.