What’s the Difference Between a Roth IRA and a Traditional IRA?

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An individual retirement account (IRA) is a simple way to save for retirement, and it's something you can do on your own. There are two types of IRA to choose from: Roth and traditional. The main differences are in their tax treatment, eligibility rules and in what situations you can withdraw money penalty-free.

It's important to first understand whether an IRA is your best retirement savings option. If you have a 401(k) through work and your employer matches your contributions up to a certain percentage of your income, it's usually best to max out that account before contributing to an IRA.

But an IRA can be a good option if you don't have a 401(k), or you want to save beyond it; you're a business owner; or you want to roll over funds from a prior employer's 401(k) to your own plan.

Once you've decided an IRA is the right move for you, here's how to decide which type to choose.

What Is a Traditional IRA?

A traditional IRA is a tax-deferred retirement account, meaning you'll pay taxes when you withdraw from the account. You're allowed to make deposits up to a certain dollar amount each year and will be penalized if you withdraw the money early. Here are the details on the main features of a traditional IRA:

  • Annual contribution limit: For 2020 and 2021, you can contribute up to $6,000, or $7,000 if you're 50 years old or over.
  • Tax on withdrawals: All contributions and earnings are taxable upon withdrawal.
  • Tax deduction: You can take a full deduction of IRA contributions on your tax return if you and your spouse don't have access to a retirement plan at work. Your deduction might be capped if you or your spouse has a workplace retirement plan and you earn above a certain amount, based on filing status.
  • Penalty for early withdrawals: You'll pay income tax and a penalty of 10% if you withdraw contributions or earnings before age 59½. You won't pay the 10% penalty in certain circumstances, such as if you make an early withdrawal to pay for a first home (up to $10,000) or for certain higher education expenses.
  • Required minimum distributions: You must start taking required minimum distributions by April 1 the year after you turn 72. That's if you turn 70½ on or after January 1, 2020—if you turned 70½ before that, you must have started taking required minimum distributions at 70½.
  • Income eligibility requirements: None. You can contribute no matter how much you earn or how old you are.

What Is a Roth IRA?

A Roth IRA is a twist on the traditional IRA. You'll contribute post-tax, which means you won't pay taxes on withdrawals in retirement. You can't contribute if you earn over a certain amount per year, and you can't deduct contributions on your tax return. But there are no required minimum distributions, and you can withdraw contributions anytime without tax or penalty. Here are the details:

  • Annual contribution limit: For 2020 and 2021, you can contribute up to $6,000, or $7,000 if you're 50 years old or over.
  • Tax on withdrawals: No tax or penalties on withdrawals of contributions. No tax or penalties on withdrawals of earnings if you've had the IRA for at least five years and if: you're over age 59½, the account owner has died, you're disabled or you're buying a first home (up to $10,000).
  • Tax deduction: None.
  • Penalty for early withdrawals: You'll pay a 10% penalty on early withdrawals of earnings if you're under age 59½ unless you meet certain circumstances, such as if you pay for a first home (up to $10,000) or for certain higher education expenses.
  • Required minimum distributions: None during the account owner's lifetime.
  • Income eligibility requirements: For 2020, you can't contribute to a Roth IRA if you earn $206,000 or more if married filing jointly, and $139,000 or more if single.
IRA Comparison
Roth IRATraditional IRA
Maximum annual contribution (2020)$6,000 ($7,000 if age 50 or over by end of year)$6,000 ($7,000 if age 50 or over by end of year)
Maximum income allowance$139,000 for individuals filing as single; $206,000 for married couples filing jointlyNone
Contributions tax-deductible?NoMaybe, depending on your income and whether you have a retirement plan at work
Withdrawal of contributions subject to income tax?NoYes
Withdrawal of fund earnings subject to income tax?Maybe, if withdrawals are made before age
59 1/2
Early withdrawal penalty?Some withdrawals of fund earnings made before age
59 1/2 are subject to 10% penalty
10% penalty on some withdrawals made before age
59 1/2
Age restriction on contributionsNone70 1/2
Age when distributions become mandatoryNone70 1/2

How to Determine Which IRA Type Is Best for You

Since tax treatment is the most significant difference between a Roth and traditional IRA, your potential tax bracket in retirement will be a big consideration when deciding. But there are other ways to make the choice too. Consider:

  • Current income: Roth IRAs have income limits for eligibility, so if you earn too much, you won't be able to contribute.
  • Future income: When you contribute to a Roth IRA, you pay income tax on the money now, then take it out tax-free. That makes it a good option for people who believe they're currently on the lower end of their income trajectory, and will therefore pay less tax now than they would later on when they retire.
  • Career stage: It's hard to know how much you'll earn in the future, but you can start to make that determination by considering your career path. Are you earning a lot now, but think you might switch careers or work less outside the home later on? Then maybe a traditional IRA is a better choice, since you'll pay tax on withdrawals based on your future tax rate.
  • Flexibility in withdrawals: A Roth IRA lets you take out money you've contributed any time, without taxes or penalties. If you withdraw money you've saved, you'll lose out on future investment earnings. But if you've saved a comfortable amount for retirement across your accounts and it makes sense to do so, withdrawing contributions from a Roth IRA is easier and less costly.
  • You're self-employed or a business owner: A simplified employee pension (SEP) is a type of traditional IRA that some self-employed individuals or business owners can contribute to. In 2020, you can contribute up to 25% of an employee's annual compensation or $57,000, whichever is smaller, per employee per year to an SEP IRA. That can provide a substantial tax break if you qualify.

There are traditional and Roth versions of 401(k) plans, so if you're unsure whether to choose between a traditional and Roth IRA, one option is to vary the account from the type you have at work (assuming your employer offers both choices). Perhaps you have a traditional 401(k) as your workplace retirement plan; in that case, you may want to opt for a Roth IRA. That can help you cover your bases if you don't know whether it will be beneficial to pay tax on your savings now or in the future.