Traditional IRA vs Roth IRA

An individual retirement account (IRA) lets you invest funds for retirement while offering certain tax advantages. Because an IRA is opened and funded on your own, you don’t have to hassle with transferring your account if you decide to switch employers.

There are also several different types of IRAs, but the most common are the traditional IRA, Roth IRA, SEP IRA, and SIMPLE IRA. For this article, we’re going to focus on two of the more popular IRAs for investors: the traditional and Roth accounts.

Both have the same purpose — to give investors a place to save for retirement separate from their employers. However, each of these accounts have different tax structures that should be considered before selecting one over the other.

Traditional IRAs: What you need to know

A traditional IRA is an account where you can invest money for retirement. Unlike a Roth IRA, you can receive a tax deduction for your contributions, potentially offsetting your tax liability for that tax year — if you qualify.

With a traditional IRA, you pay taxes when you make a withdrawal. In that sense, by offsetting your taxes earlier in life with the traditional IRA tax deduction, you can potentially wait until you start taking distributions in retirement to pay taxes on your earnings instead.

This makes the account great for someone who estimates their income at retirement will be lower, when they’ll hypothetically be in a lower tax bracket and pay less income tax on the IRA distributions.

But if you take a distribution from your traditional IRA before age 59 ½, you may owe an additional 10% tax penalty — if it’s not a qualifying life event which could be considered an exception.

Roth IRAs: What you need to know

A Roth IRA is an account where you can invest post-tax money for your post-career years. Because Uncle Sam has already taken his fair cut, investors won’t pay taxes on distributions from a Roth IRA if they’re over 59 1/2.

This tax strategy is potentially advantageous for someone who estimates they will be in a high tax bracket at that age.

So while Roth IRAs don’t offer any tax benefit upfront, you will reap the rewards by investing for the long-term.

Traditional IRA vs Roth IRA: The similarities and differences

An IRA is a solid option to begin your investing journey and save for retirement. If you have access to an employer-sponsored retirement account like a 401(k), the IRA can act as a supplemental account to potentially supercharge your investing. But of these two, which should you choose? Here’s what to consider:

But of these two, which should you choose? Here’s what to consider: 

	Traditional IRA	Roth IRA
Funded with	Pre-tax money, potentially offset by tax deduction if you qualify	Post-tax money, not offset
2023 IRA contribution limits	$6,500 ($7,500 if over 50 years old), total across all IRAs you have	$6,500 ($7,500 if over 50 years old), total across all IRAs you have
Contribution deadline	You have from January 1st, 2023, to April 15, 2024, to maximize your 2023 contributions.	You have from January 1st, 2023, to April 15, 2024, to maximize your 2023 contributions.
2023 income limits	None	Equal or greater than: $153,000 for single filers $228,000 for married filing jointly (modified AGI)  Once you hit the threshold, no more funds can be added
Required minimum distributions	Start at 73 years old	None while account owner is alive; estate must make RMDs starting at what would’ve been account owner’s 73rd birthday
Early withdrawal penalty	10% on any withdrawals	Contributions are penalty free, gains have a 10% penalty
Withdrawals after 59.5 years old are taxed	Yes, at ordinary income tax rates based on the individuals tax bracket	No

There are also a few more rules to keep in mind as you choose which IRA account is best for your needs: 

• You can fund both within the same tax year if you wish. However, the contribution limits apply across IRAs. For example, you could contribute $3,250 to both a traditional and Roth IRA in the 2023 tax year. (Learn more about how many IRAs you can have.)

• If you need to access your funds prior to retirement, there are a few exceptions that can circumvent penalties, such as: unreimbursed medical expenses, health insurance premiums if you’re unemployed, for education costs, for a home purchase or renovation, or if you become permanently disabled. This list is not exhaustive, and the amount you can withdraw for each expense may be limited, so be sure to check with a certified financial professional to see if your life event qualifies.

Learn more about the difference between brokerage accounts and IRAs.

How to invest in an IRA

Once you open the account and deposit money, there’s one more step to complete — investing the money in stocks, ETFs, or other securities. If you simply leave money in an IRA and don’t invest it in something, then all you’ve done is stashed the money away. To begin investing your money, you’ll need to purchase securities using your IRA. So once you have funds inside the account, be sure to research and find which investments work best for your own financial goals. At M1, we have Pies predesigned to give you an easy investing experience.

Traditional IRA vs Roth IRA: The M1 bottom line

An IRA is a great option to continue investing for the long term, rather than regularly buying and selling securities. However, as you decide whether the traditional IRA vs Roth IRA is best for you, it may be beneficial to consult with a licensed tax professional to see which one makes more sense for you.

M1 and its affiliates do not provide tax, legal, or accounting advice. This material has been prepared for informational purposes only. It is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal, and accounting advisors before engaging in any transaction.

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