Understanding the difference between a Roth IRA and a Traditional IRA

An Individual Retirement Account can be a smart way to save for retirement. This quick guide will help you learn the basics.
by Ellen Sheng |January 29, 2024

An individual retirement account (IRA) offers significant tax benefits and investment options, so it can be a smart way to supplement a 401(k) or a good alternative for people who don’t have access to a workplace-provided retirement plan. To help you understand if a Traditional IRA or a Roth IRA is right for you, here’s a quick breakdown of both. 

How a traditional IRA compares with a Roth IRA 

They’re taxed differently.  

Traditional IRAs are funded with pre-tax money. You get a tax break for what you put into the IRA and pay income tax when you withdraw. A Roth IRA, on the other hand, is funded with after-tax money. You pay taxes now, but in retirement you can withdraw all your investment gains tax-free. 

They have the same contribution limits. 

The yearly contribution limit for a traditional IRA or a Roth IRA in 2023 is $6,500, or $7,500 if you’re 50 or older. You have until the April 15 tax filing deadline to contribute for the previous year. If you contribute to both a traditional IRA and a Roth IRA, the limit includes the combined contributions made to both accounts.  

A Roth IRA offers more flexibility… 

A traditional IRA requires you to start taking out some money every year when you turn 72. These withdrawals, called required minimum distributions, are calculated by dividing the account balance by a life expectancy factor. The IRA has worksheets to help you calculate the amount. With Roth IRAs, you get to decide when to begin making withdrawals. If there’s money left in this account after your death, it can be left to heirs, and they can withdraw it tax-free. You can also take out money from a Roth IRA before age 59 ½ without paying an additional 10% penalty so long as it’s for certain uses such as buying a home or covering education or medical expenses. (Early withdrawals can be made from a traditional IRA under IRS Rule 72(t), but the guidelines are complex and you may want to consult a tax advisor first.) 

… but a Roth IRA also has stricter eligibility parameters.  

Anyone can contribute to a traditional IRA, regardless of their income. But a Roth IRA has income limits. The income and contribution limits vary depending on how you file your taxes.  

For example, in 2024, if you are married and filing jointly, you can only open a Roth IRA if you have a modified gross income under $218,000.  In other words, if you have a very high income, a traditional IRA is the only choice.  

How to decide which account is right for you  

Taxes play a large role in determining which type of IRA makes the most sense for you. If you think you’ll have less income in retirement than in your peak earning years, it might be more beneficial to go with a traditional IRA because you will be taxed upon withdrawal, when you are are in a lower tax bracket. 

“Theoretically, we should compare our tax bracket now and estimate our tax bracket in the future, but it's a little difficult to do in reality,” says Rui Yao, a professor of graduate studies and director of the international financial planning initiative at the University of Missouri. “Marital status, career trajectory or a career change, or leaving the workforce to care for a loved one are all things that can affect your tax bracket. Such events are hard to predict with any certainty.,” 

If you’re in a position to contribute to both, you’ll have the choice of taxable and non-taxable withdrawals when you retire. Having non-taxable income can be handy if you have unexpected expenses, such as a medical bill, that forces you to pull a large amount from your savings. Withdrawing this from a traditional IRA would incur more taxes and potentially bump you into a higher tax bracket. If you have a classic 401(k) which works like a traditional IRA, having a Roth IRA can provide some tax diversification in retirement.  

How to open an IRA 

Investment retirement accounts are easy to set up through your bank, brokerage or other financial institution. You can arrange for automatic contributions directly from a checking or savings account. (Note that the IRS doesn’t require a minimum amount to open an IRA, but some providers require account minimums for investing with their brokerage or bank). 

Once you’ve opened an IRA, you need to decide what to invest in. Index funds, ETFs and mutual funds are popular choices because they let you invest in a variety of stocks or bonds. An index fund follows an index, like the S&P 500, while an ETF, or exchange-traded fund, is traded on a stock exchange and holds a basket of stocks, bonds or commodities.  If you have questions about how an IRA fits into your investment plans, consult a financial advisor.

The content reflects the view of the author of the article and does not necessarily reflect the views of Citi or its employees, and we do not guarantee the accuracy or completeness of the information presented in the article.
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