The main difference between these two IRAs comes down to when your money is taxed: before you contribute or after you withdraw. You contribute to a traditional IRA with pretax money, but you’re taxed on your withdrawals. You contribute to a Roth IRA with after-tax money and enjoy tax-free withdrawals. Here’s a closer look at what that means to help you make the right choice for your financial situation.

What’s the Difference Between Traditional and Roth IRAs?

Contributions

Traditional IRAs require pretax contributions. You don’t pay any taxes on that income during the year of your contribution, but taxes are required on withdrawals you take when you retire. Ideally, you’ll save on taxes long term due to this strategy, assuming you have lesser earnings and a lower income tax rate during your retirement period. Contributions are made after tax with a Roth IRA. You pay taxes on that income in the year of your contribution, but qualified withdrawals are tax free. This means that all capital gains aren’t taxed. This could be more valuable to you than the traditional IRA pretax deduction benefit if you have a long time ahead of you before retirement.

Annual Contribution Limits

Both types of accounts also have a maximum contribution amount per year, set by the Internal Revenue Service (IRS) annually. The limit for Roth and traditional IRA contributions was $6,000 in 2022, or $7,000 if you were age 50 or older in that calendar year. The limits increase to $6,500 if you’re younger than 50 and $7,500 for those aged 50 or older in 2023. But some people can’t contribute anything to a Roth IRA. These accounts have an income limit for contributions, which keeps some high earners out. If your modified adjusted gross income is over IRS thresholds, the amount you can contribute phases out to zero. For 2022, individuals earning $144,000 and married couples who file jointly and earn $214,000 or more cannot contribute at all to a Roth IRA. These limits increase to $153,000 and $228,000 respectively in 2023.

Qualified Withdrawals

Qualified withdrawals for both IRA types are available when you reach the age of 59½. Remember that traditional IRA withdrawals are taxed, while Roth IRA withdrawals are tax free. You’re able to withdraw from either of your retirement accounts without paying additional penalties at age 59½. You may have to pay both taxes and a 10% tax penalty if you withdraw from a traditional IRA before that age, making it a costly proposition. You can withdraw contributions from your Roth at any time without penalty because that money has already been taxed. But more rules apply when you can withdraw the account’s earnings. You can only pull earnings out of a Roth after age 59½. Withdrawing earlier could trigger taxes and a 10% penalty.

Required Minimum Distributions

You must take required minimum distributions (RMDs) at age 72 if you have a traditional IRA. The amount you must withdraw uses a complex formula based on your age and account balance. Check with the IRS or your investment brokerage to ensure you don’t make any mistakes here, because you could wind up with additional taxes or penalties. A Roth IRA does not require that the account owner take a required minimum distribution. You can leave your contributions and earnings in your Roth IRA until you die.

Account Investments and Availability

Both IRA types allow investors to choose from any supported market investments, including ETFs, mutual funds, stocks, and bonds. You can open either IRA type at a brokerage or bank.

Which Is Right for Me?

Generally, younger investors benefit most from a Roth IRA early in their careers because their investments will grow tax free for decades. Younger investors might also make less money annually at work and therefore fall within the income requirements to make a maximum contribution. These investors can withdraw significant earnings without paying capital gains taxes in retirement. The pretax benefits of traditional IRAs may prove more valuable for investors who are closer to retirement because they have fewer years for their investments to grow before they stop working. Higher-income earners who make too much to contribute to a Roth can still contribute to a traditional IRA. Older investors might find the tax-deduction advantages of a traditional IRA appealing. Remember, you can also make catch-up contributions of up to $7,500 after age 50 beginning in 2023 with no income restrictions.

A Best-of-Both Worlds Option

No law says that you can’t have both a traditional and Roth IRA, although it may be complicated to contribute to both in the same calendar year. Some savers get benefits similar to those of a traditional IRA when investing with an employer-sponsored 401(k) plan or a similar retirement account. They can still use a Roth IRA as well for after-tax benefits. Combining a 401(k), IRA, and health savings account (HSA) helps you layer on tax savings through multiple investment accounts if you’re eligible. No perfect solution exists for everyone, but you can work through your budget, your savings ability, and anticipate your future needs to find the savings method and investment account that make the most sense for your retirement.

The Bottom Line

Investing is critical for most Americans who are looking to maintain the same standard of living during retirement as they enjoyed during their working years. Many investment experts suggest saving at least 15% of your pretax income for retirement, including through individual retirement accounts, 401(k) accounts, and other tax-advantaged accounts. An IRA could be the perfect fit for you if you’re not yet saving for retirement or don’t have access to an employer-sponsored retirement account.