When to contribute to a Roth IRA vs. a Traditional IRA

Written By Jon Scott

In this article we’ll cover:

• The rules when contributing to a Roth IRA vs Traditional IRA

• Required Minimum Distributions

• Special considerations when investing for retirement

• Which retirement option should you contribute to

• Traditional IRA to Roth IRA

The type of IRA you contribute to at the beginning of your career will likely not be the IRA you contribute to at the end. If you expect your income to change dramatically over your career, then the IRA type you contribute to will make a huge difference down the road.

Roth IRA vs. Traditional IRA

Let’s Break Each Down Further

Eligibility

Eligibility really sits at the crux of why these accounts differ. Roth IRAs were made for income earners who expect to make more money as they grow older, whereas Traditional IRAs are for those who expect to make less money in retirement. Therefore, the income limits imposed on Roth IRAs are to keep out individuals and couples who already have significant income. In contrast, a traditional IRA is available to all earned income individuals and couples and is advantageous for those who will earn less in retirement.

Contribution Limits

Contribution limits for both IRA accounts are the same.

Pre-Tax vs Post-Tax

Tax status is very much where the difference in philosophy between these two accounts begin. Roth IRA contribution is made with post-tax contributions only, meaning the money is already taxed before it goes into the account. You can contribute both pre-tax and post-tax money to a traditional IRA.

Tax on Earnings

Technically investments earnings in both accounts grow tax-free, but a Traditional IRA is known as tax-deferred because taxes are withdrawn once you start making distributions.

Age to Withdraw

Age to withdraw without penalty is the same for both accounts at 59 ½. In addition, both have the same penalty-free withdrawal policy.

Tax on Distributions

Roth IRAs have no taxes on distributions. However, Traditional IRAs do have taxes on distributions. For a Traditional IRA, the age to begin withdrawing without penalty is 59 ½, and these withdrawals will be taxed at the income tax rate applicable in the tax year the withdrawal is made. Additionally, Traditional IRAs will be subject to Required Minimum Distributions.

Required Minimum Distribution (RMD)

Employee sponsored retirement plans (including 401K), traditional IRA, SEP, or SIMPLE IRA all have required minimum distributions once the participant reaches retirement age. Roth IRAs do not have RMDs. Currently, the age at which the individual must begin taking RMDs is 72 years old. You are able to take out more than the RMD, but not less. RMDs protect the account holder from paying taxes.

The IRS has a worksheet to help taxpayers determine the amount that needs to be withdrawn. Additionally, the RMD taken from the account is taxed at the account holder's current income tax rate. There are some plans that allow an individual to not take out a RMD if they are still working, so you will want to check with your employer if you plan to continue working past age 72.

Special Considerations

How Much Can I Contribute to an IRA if I have a 401K from my Employer?

The ability to contribute to an IRA when you are also contributing to a 401K depends on the type of IRA you are contributing to.

2022 Income Limits for Traditional IRA when contributing to a 401K

2022 Income Limits for Roth IRA

So, Which Should I Contribute To?

The most important factor is when you expect to earn more income: at present, or in the future? If you are currently in your high income-earning years or at least think you will have less income in retirement, you will want to contribute to a Traditional IRA. However, if you believe you will earn more in the future, a Roth IRA is the best account to contribute to.

Again, this is because a Traditional IRA will require you to pay the applicable income tax on your IRA at the time of your withdrawal, whereas Roth IRA is taxed at the time the money is contributed, but not taxed at any time after (as long as it is a qualified withdrawal or after age 59 ½).

Traditional IRA to Roth IRA

Your income situation will most likely shift as you grow older, meaning if you were contributing to a Traditional IRA initially, you may decide to start contributing to a Roth IRA as your income decreases. Additionally, you will likely also decide to convert your traditional IRA to a Roth IRA to take advantage of the lower tax rate upon converting. Remember that contributions to your Roth IRA are still capped at $6,000 ($7,000 for those 50 and older) per year, so if you have built up a large traditional savings, you will not be able to transfer all the funds at once.