Roth vs. Traditional IRA: How They Work and How to Choose

What's the difference between a Roth and a traditional IRA?

An IRA (individual retirement account) is a retirement account you open yourself, at a bank or brokerage, separate from any job. The two main kinds differ in when you pay income tax:

• Traditional IRA: your contributions may lower your taxes this year, and you pay income tax when you take the money out in retirement.
• Roth IRA: no tax break now, but the money, including everything it grows into, comes out tax-free in retirement if you follow the rules.

If your tax rate is the same now and in retirement, the two come out exactly even. So the real question is whether you expect your tax rate to be higher now or later.

I have both kinds, mostly from rolling old workplace accounts into IRAs of my own when I changed jobs.

Tax the seed, or tax the harvest

Think of the money you put in as seeds, and what it grows into over the decades as the harvest. The government gets its share of income tax once, either way. You just pick when:

• A Roth taxes the seeds. You plant money you've already paid tax on. Whatever grows from it, however big, is yours to harvest untaxed.
• A traditional IRA taxes the harvest. You plant seeds before tax, so you get to plant more for the same cost. But when you harvest in retirement, every withdrawal is taxed as income.

It sounds like the Roth must win, since the harvest is so much bigger. But the traditional IRA lets you plant more seeds for the same cost.

Same tax rate, same result

Here's the round-number test. Say your top tax bracket is 22%, and you set aside $3,900 of take-home pay for retirement this year. (To keep it simple, this ignores state taxes.)

• Roth: you plant the $3,900. It's already been taxed.
• Traditional: you can plant $5,000. Putting $5,000 in lowers your income tax by $1,100 (22% of $5,000), so it still costs you only $3,900 of take-home pay.

Now let each grow at 7% a year (an example, not a promise; what rate will you actually get? explains why) for 30 years:

• Roth: $3,900 grows to $29,687.79, all tax-free.
• Traditional: $5,000 grows to $38,061.28. Take it out at the same 22% rate, and you keep $29,687.79.

To the penny, the same. Taxing the seeds or the harvest at the same rate gives you the same crop, so the choice only matters if your tax rate changes.

One catch: the traditional IRA only keeps up because you plant the whole $5,000. If you'd spend the $1,100 tax break instead, the Roth comes out ahead.

Which one wins when your tax rate changes?

Keep the same example, but change the tax rate in retirement:

Tax rate in retirement	Traditional, after tax	Roth	Comes out ahead
Lower: 12%	$33,493.92	$29,687.79	Traditional, by $3,806.13
Same: 22%	$29,687.79	$29,687.79	A tie
Higher: 32%	$25,881.67	$29,687.79	Roth, by $3,806.12

Try it with your own numbers. The calculator opens on this example, a tie at 22% both now and later. Change Tax rate in retirement to 12% or 32% and watch the winner flip, or switch How often to Every year to see a yearly habit instead of a one-time amount. The Roth vs. traditional calculator has the same tool on its own page.

So the rule of thumb is the same one from the 401(k) post:

• A traditional IRA tends to fit when you expect a lower tax rate in retirement than now, often people in their peak earning years.
• A Roth IRA tends to fit when you expect the same or a higher rate later, often people early in their careers, in a low bracket today.

Nobody knows their future tax rate for sure, which is why some people keep money in both kinds and decide later which to draw from. That's where I've ended up. Check Compare a 50/50 split in the calculator to see it: half in each always lands right between the two, never the best and never the worst.

What else is different?

	Traditional IRA	Roth IRA
Tax break now	Yes, though it can shrink or disappear at higher incomes if you (or your spouse) have a retirement plan at work	No
Taxed in retirement	Yes, as income	No, if you're 59½ and the account is at least 5 years old
Income limit to contribute	None	Yes: higher earners can put in less, or nothing
Taking out what you put in early	Taxed, usually plus an extra 10%	Your contributions (not their growth) can come out anytime, tax- and penalty-free
Required withdrawals	Yes, starting in your 70s	None during your lifetime

That fourth row makes a Roth a little more flexible, but an IRA still works best for money you won't need for decades. Keep your emergency fund in a savings account instead.

The IRS has the details on both kinds of IRA (opens in a new tab), when a traditional IRA is deductible (opens in a new tab), Roth IRAs (opens in a new tab), early withdrawals (opens in a new tab), and required withdrawals (opens in a new tab).

Who can open an IRA, and how much can you put in?

• You need earned income: pay from a job or self-employment. Investment income doesn't count. A spouse without a paycheck can still have one, based on the working spouse's income.
• There's a yearly limit, set by the IRS, plus an extra catch-up amount from age 50. It's one limit for all your IRAs together, traditional and Roth combined, and it's separate from your 401(k) limit. The IRS lists the current IRA limits (opens in a new tab).
• You have until tax day. Contributions for a year can usually be made until the tax filing deadline the next spring, so there's still time after December 31.

One thing that surprises people: an IRA is just the account. Once the money is in, you choose what it's invested in. Money left sitting as cash won't grow much.

IRA or 401(k): which comes first?

If your job offers a 401(k) with a match, a common order is to get the full match first, since that's money you'd otherwise leave behind. After that, an IRA is one of the options for your next dollar: it often has more investment choices than a workplace plan, and a Roth IRA adds tax-free money to the mix if your 401(k) is traditional, like mine.

If your job doesn't offer a retirement plan at all, an IRA may be where your retirement saving starts. This is educational, not financial advice; for a big decision, consider talking with a tax professional or financial planner.

Why it matters

Retirement is the longest goal most of us have, and the one where compound interest has the most time to work. An IRA adds a tax break on top, now or later, even if your job offers nothing. And with some of each kind, I don't have to guess today what tax rates will look like when I retire.

What to take with you

• The difference is timing. Traditional saves tax now; Roth saves it later. At the same tax rate, they come out even.
• Guess your tax rate now vs. in retirement. Lower later points to traditional; the same or higher points to Roth.
• Check the rules for your income: the Roth limit, and whether a traditional IRA is deductible with a plan at work.
• Get any 401(k) match first, then consider an IRA for your next dollar.
• Invest the money once it's in. An IRA is the account, not the investment.
• Remember the deadline. You can usually contribute for a year until tax day the next spring.

Want to test your own tax rates? Try the Roth vs. traditional calculator, or see what your contributions could grow into with the compound interest calculator.