Table of Contents
Table of Contents
Pros of IRAs
Cons IRAs
FAQs
The Bottom Line
- IRAs
- Roth IRAs
Both offer tax-advantaged savings, but there are key differences
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Updated August 29, 2024
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Traditional individual retirement accounts (IRAs) and Roth IRAs are both widely used investment vehicles for workers trying to accumulate long-term assets. However, the way these two accounts work is different, with each having its own advantages and disadvantages.
The IRA was created decades ago as defined-benefit pension plans were declining. Becoming more popular as workers started to take control of their retirement savings, the IRA offers individuals an opportunity to save for retirement in a tax-advantaged account.
In a traditional or Roth IRA account, you can invest in all sorts of traditional financial assets, such as stocks, bonds, exchange-traded funds (ETFs), and mutual funds. You can invest in a wider range of investments through a self-directed IRA (one in which you, the investor, not a custodian, make all the investment decisions)—your options may include commodities, certain precious metals, real estate, or even peer-to-peer loans. However, no matter which type of IRA, you may not invest in life insurance or in collectibles such as artwork, rugs, antiques, gems, and stamps.
IRA accounts are relatively easy to set up, but the rules that govern these accounts vary. While they offer tax benefits, there are limits to how much you can contribute.
Key Takeaways
- Traditional and Roth IRAs are popular retirement accounts and are easy to set up.
- Both offer a tax-advantaged way to save and invest for retirement.
- Roth IRA contributions do not qualify for immediate tax deductibility, but investment growth may be distributed at retirement tax-free.
- Although traditional IRA contributions can reduce your current tax liability, qualified withdrawals are taxed at retirement.
- There are limits to how much you can contribute and penalties for early withdrawals.
Benefits of Traditional and Roth IRAs
IRAs offer several distinct advantages, including the following:
Tax-Free Growth
Both Roth and traditional IRAs offer immediate tax-free growth of assets. This means that once the money is in the account, no taxes are levied on the dividends or capital gains that the investments earn until distribution.
The Roth IRA takes this one step further. Having paid taxes on contributions, all qualified earnings in the future can be withdrawn tax-free. That makes Roth accounts particularly helpful to millennials who have a long time to grow the funds. Be mindful that although no taxes are due for non-distributions from a traditional IRA leading up to retirement, distributions are taxable for a traditional IRA.
Tax Deductions
While Roth IRA contributions are made with after-tax dollars, traditional IRA contributions are made with pre-tax dollars. This means that in most cases, traditional IRA contributions can be deducted from your income—although there are certain limitations.
The deductibility is determined by income levels as well as whether you are covered by a workplace retirement account, such as a 401(k). The limits are determined based on income and the individual's tax-filing status. As a person's income increases, the amount of the tax deduction that can be taken can be reduced partially or fully. Below are the deduction limits for 2023 and 2024.
| 2023 Traditional IRA Deduction Limits | ||
|---|---|---|
| Filing Status | 2023 Modified AGI | Deduction |
| Singleor head of household | $73,000 or less | A full deduction up to the amount of thecontribution limit |
| More than $73,000 but less than $83,000 | A partial deduction | |
| $83,000 or more | No deduction | |
| Married filing jointlyorqualifying widow(er) | $116,000 or less | A full deduction up to the amount of thecontribution limit |
| More than $116,000 but less than $136,000 | A partial deduction | |
| $136,000 or more | No deduction | |
| Married filing separately | Less than $10,000 | A partial deduction |
| $10,000 or more | No deduction | |
| 2024 Traditional IRA Deduction Limits | ||
|---|---|---|
| Filing Status | 2024 Modified AGI | Deduction |
| Singleor head of household | $77,000 or less | A full deduction up to the amount of thecontribution limit |
| More than $77,000 but less than $87,000 | A partial deduction | |
| $87,000 or more | No deduction | |
| Married filing jointlyorqualifying widow(er) | $123,000 or less | A full deduction up to the amount of thecontribution limit |
| More than $123,000 but less than $143,000 | A partial deduction | |
| $143,000 or more | No deduction | |
| Married filing separately | Less than $10,000 | A partial deduction |
| $10,000 or more | No deduction | |
If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the single filing status.
Both traditional and Roth IRAs have the same contribution deadline. You are allowed to contribute to your IRA during the entire calendar year and up to the tax filing deadline of the following year.
Drawbacks of Traditional and Roth IRAs
While the pros of IRAs generally outweigh the cons, there are a few drawbacks to be aware of.
Contribution Limits
IRAs have strict contribution limitations. To contribute to an IRA, you or your spouse need earned income. For 2024, the maximum contribution amount per person is $7,000, a $500 increase from 2023, and those aged 50 and older can make a $1,000 catch-up contribution. However, if your modified adjusted gross income (MAGI) exceeds a certain level, you may not be able to contribute to a Roth IRA.
| 2023 Roth IRA Income Limits | ||
|---|---|---|
| Filing Status | 2023 Modified AGI | Contribution Limit |
| Married filing jointly or qualifying widow(er) | Less than $218,000 | $6,500 ($7,000 if you're age 50 or older) |
| $218,000 to $228,000 | Reduced | |
| $228,000 or more | Not eligible | |
| Single, head of household, or married filing separately (and you didn't live with your spouse at any time during the year) | Less than $138,000 | $6,500 ($7,000 if you're age 50 or older) |
| $138,000 to $153,000 | Reduced | |
| $153,000 or more | Not eligible | |
| Married filing separately (if you lived with your spouse at any time during the year) | Less than $10,000 | Reduced |
| $10,000 or more | Not eligible | |
| 2024 Roth IRA Income Limits | ||
|---|---|---|
| Filing Status | 2024 Modified AGI | Contribution Limit |
| Married filing jointly or qualifying widow(er) | Less than $230,000 | $7,000 ($8,000 if you're age 50 or older) |
| $230,000 to $240,000 | Reduced | |
| $240,000 or more | Not eligible | |
| Single, head of household, or married filing separately (and you didn't live with your spouse at any time during the year) | Less than $146,000 | $7,000 ($8,000 if you're age 50 or older) |
| $146,000 to $161,000 | Reduced | |
| $161,000 or more | Not eligible | |
| Married filing separately (if you lived with your spouse at any time during the year) | Less than $10,000 | Reduced |
| $10,000 or more | Not eligible | |
If you were married filing separately and you did not live with your spouse at any time during the year, your tax status is single.
Penalties
Since the IRA is intended for retirement, there are often certain penalties if you take out your money before retirement age. With the traditional IRA, you face a 10% penalty on top of the taxes owed for any withdrawals before age 59½. With the Roth IRA, you can withdraw a sum equal to your contributions penalty and tax-free at any time.
However, you can only withdraw earnings without getting dinged with the 10% penalty if you’ve held the account for five years and have reached age 59½.
There are a few exceptions to these early withdrawal rules. Early distributions of earnings for these reasons are considered exceptions: taxable as income but not subject to the 10% penalty. The most popular include:
- Withdrawals up to $10,000 to help pay for the first home for yourself, your spouse, children, or grandchildren
- Withdrawals to pay for college expenses
- Withdrawing up to $5,000 in the year after the birth or adoption of your child
- Distribution for unreimbursed medical expenses that exceed 10% of your adjusted gross income for the year or health insurance premiums while you are unemployed
Required Withdrawals
There are mandatory withdrawals for your traditional IRA called required minimum distributions (RMDs), starting when you reach age 73. The withdrawal amount is calculated based on your life expectancy, and it will be added to that year's taxable income. There is a 25% penalty, plus taxes owed if you fail to take the RMD. If corrected promptly, that penalty can be reduced to 10%.
A popular benefit of the Roth IRA is that there is no required withdrawal date. You can leave your money in the Roth IRA to let it grow and compound tax-free as long as you live. What's more, any money you choose to withdraw is tax-free.
What Are the Main Advantages of an IRA?
Both the traditional individual retirement account and Roth IRA offer key tax advantages. A traditional IRA allows you to deduct all or part of your contributions, depending on your income level, and your balance grows on a tax-deferred basis. With a Roth IRA, you invest post-tax dollars, but have the ability to withdraw money tax-free if you're at least age 59½ and owned the account for at least five years. And compared to workplace plans, you have access to more investment choices.
Are There Disadvantages to an IRA?
Compared to workplace retirement plans, the contribution limits for an IRA are fairly modest. In 2023, you could contribute up to $6,500, or up to $7,500 if you're age 50 or older. That amount increased to $7,000 or up to $8,000 for people 50 or older in 2024. Like 401(k)-style plans, you may face a tax hit and a penalty if you withdraw the money early, which makes them less attractive to investors who need more flexibility in the short term.
What's the Difference Between an IRA and a Roth IRA?
There are several distinctions between these two versions of the individual retirement account. Traditional IRAs offer an upfront tax benefit, whereas Roth IRAs provide a back-loaded tax benefit. In other words, you can deduct all or part of your contributions to a traditional IRA but have to pay income tax on withdrawals in retirement. With a Roth IRA, you can contribute post-tax money but have the opportunity to make tax-free withdrawals later on.
Another key difference: traditional IRAs require you to make required minimum distributions, or RMDs, starting at age 73. That's not the case with Roth IRAs.
The Bottom Line
IRAs can be a powerful savings tool, especially if you've maxed out your 401(k) contributions or don't have access to a workplace retirement plan. Those in a relatively low tax bracket now may want to consider a Roth IRA, where you contribute post-tax dollars but have the opportunity to withdraw funds tax-free in retirement, when you may be in a higher bracket.
Article Sources
Investopedia requires writers to use primary sources to support their work. These include white papers, government data, original reporting, and interviews with industry experts. We also reference original research from other reputable publishers where appropriate. You can learn more about the standards we follow in producing accurate, unbiased content in oureditorial policy.
Congressional Research Service. "Traditional and Roth Individual Retirement Accounts (IRAs): A Primer." Page 5.
U.S. Securities and Exchange Commission. "Investor Alert: Self-Directed IRAs and the Risk of Fraud."
Internal Revenue Service. "IRA FAQs." Select "Investments: What types of investments can I make with my IRA?"
Financial Industry Regulatory Authority. "Retirement Accounts: Types."
Internal Revenue Service. "Traditional and Roth IRAs."
Internal Revenue Service. "IRA Deduction Limits."
Internal Revenue Service. "401(k) Limit Increases to $23,000 for 2024, IRA Limit Rises to $7,000."
Internal Revenue Service. "2024 IRA Deduction Limits - Effect of Modified AGI on Deduction if You Are Covered by a Retirement Plan at Work."
Internal Revenue Service. "Publication 504, Divorced or Separated Individuals." Page 6.
Internal Revenue Service. "Retirement Topics - Exceptions to Tax on Early Distributions."
Internal Revenue Service. "Retirement Plan and IRA Required Minimum Distributions FAQs."
Internal Revenue Service. "Retirement Topics — Required Minimum Distributions (RMDs)."
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