Regular vs. Roth IRA: Compare, Then Decide

Ever since the introduction of Roth IRAs in 1997, the debate over traditional IRAs vs. Roth IRAs has continued and is likely to continue for as long as the choice remains. But one thing is certain: an individual's choice between the two is complex. The rules, requirements, and outcomes of each are different, so your choice should be made with your own personal circumstances in mind. First, you must understand how each works and what makes them different. 

Traditional IRA Basics

Traditional IRAs have been around for a long time, so most people are familiar with them. Established by Congress to encourage individual retirement savings, traditional IRAs enable individuals to save for their future by making tax-deductible contributions of up to $6,500 in 2023 ($7,500 if 50 or older). The funds within these accounts can be invested in several ways to accumulate a nest egg that isn't taxed until it is withdrawn, presumably at a lower tax rate in retirement. Any withdrawals made before age 59 ½ are subject to a 10% penalty unless certain requirements are met.  

Roth IRA Basics 

Contributions made to a Roth IRA are not tax-deductible but can be invested in the same way as a traditional IRA and allowed to grow without current taxation. The most significant difference between the two is that distributions are not taxed with the Roth IRA. Although they may be subject to the same early withdrawal penalty, some provisions allow for withdrawal of principle at any time without penalty.

Review: With a Roth IRA, you contribute after-tax dollars, your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½. With a Traditional IRA, you contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as current income after age 59½.

Other Key Differences between Traditional IRAs and Roth IRAs

Eligibility

Traditional IRAs: Anyone who does not currently participate in another qualified retirement plan, such as an employer-sponsored plan, is eligible to contribute to a traditional IRA. Those who participate in another qualified plan may make a tax-deductible contribution to a traditional IRA if their income doesn't exceed a certain amount which, for a single filer, is $83,000 and joint filers $136,000 in 2023.   

Roth IRA: Anyone can contribute to a Roth IRA regardless of whether they participate in another plan as long as their income doesn't exceed a specific income range which for single filers is $138,000 and $153,000 and joint filers $218,000 to $228,000. The contribution limit is reduced once a person's income enters the range and is disallowed entirely when it exceeds the range.

Distributions

Traditional IRA: All distributions from a traditional IRA are taxed as ordinary income. Any early distributions are subject to a penalty unless they meet certain requirements, such as the recipient is deemed disabled and cannot work, funds are used as part of a down payment on a first-time home purchase, funds are used to pay for college expenses, or they are distributed based on a schedule of equal periodic payments for life.

Roth IRA: All distributions received from a Roth IRA are tax-exempt. Early distributions are allowed to the extent that they are from the principal, which is drawn out before interest. Also, distributions can only be taken once the 5-tax year hold period has been met, meaning the initial contribution to a Roth must be held in the account for at least five years based on when the contribution was first made. The same early withdrawal penalty exclusions to traditional IRAs apply to Roth IRAs.

Minimum Distribution Rules

Traditional IRA: In 2023, Required Minimum Distributions (RMDs) must commence by age 73 and be sufficient to pay out the total balance by life expectancy. The starting age for RMDs will gradually increase to age 75 by 2033.

Roth IRA: There are no minimum distribution requirements.

Social Security Taxation

Traditional IRA: Distributions from a traditional IRA are included along with other forms of income in calculating taxes on Social Security benefits. When your income exceeds $44,000, up to 85% of your Social Security benefits become taxable.

Roth IRA: Distributions from a Roth IRA are not included in the Social Security tax calculation.

Estate Taxation

Traditional IRA: Distributions to beneficiaries are included in the estate for estate tax purposes and are also taxed to the beneficiary as ordinary income.

Roth IRAs: Also included in the estate but not taxed to the beneficiary.

Which is Best for You?

While the Roth IRA holds some clear advantages over the traditional IRA regarding eligibility, distribution flexibility, and taxation, the answer still lies in which is best for your particular situation. For many people, the Roth IRA is likely to produce the best outcome because it generates tax-free cash flow, doesn't force RMDs, and doesn't count toward taxes on Social Security benefits. 

Should I Change to a Roth?

Suppose you have a traditional IRA and are considering changing or converting it to a Roth IRA. In that case, you should know that the conversion will trigger a taxable event, which could impact the outcome. The amount of money you move from a traditional IRA into a Roth in excess of your total contributions will be taxed in the year of the conversion at your ordinary income tax rate. You can convert your traditional IRA over several years to minimize the tax bite in any given year.

An alternative is to cease contributing to your traditional IRA and start making them to a Roth. The only problem is that you will have two different IRA accounts, which can be more troublesome to administrate.

Which is right for you? 

With all the moving parts of a traditional IRA and a Roth IRA and the differences between each, it would be necessary to compare both carefully, considering your current and future financial needs. The best approach is to have your financial advisor run some comparisons to help you determine which option produces the best outcome for your retirement income plan.