Traditional IRAs and Roth IRAs are both great retirement vehicles, each with attractive perks. They allow you to save extra retirement savings apart from your employer-sponsored 401k. However, which plan should you choose over the other?

In general, Roth IRAs and traditional IRAs differ based on their income limits and the timing of the tax break, which are part of their pros and cons. With a Roth IRA, you make after-tax contributions that grow tax-free and you can withdraw at any time after age 59.5 without any taxes or penalties.

As for a traditional IRA, your contributions are either pre-tax or after-tax, with your money growing tax-deferred. At age 50, you can start making penalty-free withdrawals and mandatory withdrawals by age 72.

A traditional IRA is the best option for investors who expect to be in the lower-income tax bracket when they retire. Since you’re making contributions, you get the tax benefit of reducing your taxable income now. When you retire and start making withdrawals, you will fall into a lower tax bracket, which is a plus when you don’t have an active working life.

A traditional IRA is also preferential for high-income earners if most of the contributions are after-tax, meaning a lower tax bill in the future. The traditional IRA is also best suited for anyone as there are no income limits, unlike the Roth IRA.

However, a person can still open a Roth IRA account to optimize their retirement if they can give up the tax deduction in traditional IRAs. Whether an individual chooses a traditional IRA or Roth IRA, there are two key deciding factors to make it less complicated: 1) Investor personality and 2) goals.

When to Choose a Traditional IRA

As established, a traditional IRA has flexible income limits, allowing many people to participate. In general, anyone with earned income, including those above 72 years, is free to contribute. Depending on which stage of life you are in, for 2022, you can contribute a maximum of $6,000 each year, or $7,000 if you’re age 50 or older.

If your goal is to reduce taxable income, a traditional IRA enables you to make pre-tax contributions while minimizing your taxable income. This means that if you are a hands-on kind of investor, you have a wide choice of investment options, and you can decide how much and how often to contribute.

This promises you a sizable chunk when withdrawing, as you can invest more now and over the years on a tax-deferred basis.

When to Choose a Roth IRA

If you’re young in your career, then there’s a high likelihood your income levels could rise in the future, making a Roth IRA the right move. If you get to a higher tax bracket in retirement, a Roth IRA will allow you to make tax savings as your withdrawals will be tax-free.

A Roth IRA surpasses the traditional IRA if you seek even more flexibility. Not only are the withdrawals tax and penalty-free, but there are no required minimum distributions, and you can access your cash at any time and after reaching age 59.5. Or, if you don’t want to touch your money, you can leave your savings to keep growing tax-free for however long.

A Roth IRA also offers you a backup plan to save for other goals such as an emergency fund or education costs apart from retirement. However, you should be aware of the strict income limits. For 2022, the Modified AGI must not exceed $144,000 if you’re a single filer. If you’re filing your tax return jointly as a married couple in 2022, the MAGI must fall under $214,000.

By itself, a Roth IRA is best for an investor who has more discipline and can put off instant gratification through their working lives as their savings grow tax-free on compound interest.

Traditional IRA Pros and Cons

Pros

• You get an immediate tax deduction: With a traditional IRA, you have the advantage of deducting your contributions from your taxable income every year.
• You enjoy tax-deferred tax savings: Your pre-tax contributions can sit tax-free as they grow. You’re safe from being taxed if you gain exponential returns from stock dividends.

Cons:

• You pay taxes later on: One of the biggest downsides of traditional IRA is the government will have to collect it when you retire. You will be subject to ordinary income tax when you cash out.
• You have to make withdrawals: You have no choice but to make mandatory withdrawals when you turn 70.5, which you have to pay taxes on.
• You suffer a penalty for early withdrawal: 59.5 is the age limit to attain; otherwise, you will be slapped with a 10% penalty. However, there’s an exception if you’re paying for your first home, medical costs, or educational expenses.

Roth IRA Pros and Cons

Pros

• You don’t have to make minimum withdrawals: When you clock in at 70.5 years, no one will force you to take out your money. You have the autonomy to leave the money alone in the account for your own purposes.
• You don’t have to worry about penalties: There’s no penalty if you need to discharge money, as you have already paid taxes on the contributions.
• You get a boost to your retirement savings: A tax-free account promises big tax savings, especially if you are in a high tax bracket.

Cons

• You can’t avoid taxes at the start: You have to give up tax benefits now as you’re making pre-tax contributions. If you can’t forego the tax deduction, you may want to opt for a traditional IRA.
• You have to be under a certain income limit: If you receive a big paycheck, you may not qualify for a Roth IRA.

While a Roth IRA and traditional IRA are popularly recommended, they may not fit with the situation and needs of some investors. Almost all retirement plans offer tax advantages depending on whether it’s immediate or much later in retirement.

Those in the high-income tax bracket and who want to advance their savings need to be creative. One way is to contribute to a backdoor Roth. It’s a legal loophole where an investor converts a traditional IRA into a Roth IRA regardless of their income.

Another investor may want to optimize on an employer-matched retirement plan such as a 401(k). A 401(k) essentially offers traditional IRAs the same tax-deferred and lesser taxable income perks. The employer matching benefit is “free” money, which further boosts savings. It also offers a structured way to be consistent in savings for a person who struggles to stash retirement money away.

Whichever retirement plan an investor chooses, they primarily have the same end goal: to build retirement wealth. It all hinges on an individual’s investment goals and what kind of lifestyle they want when they retire, and having a plan that gets them there.

Make the Best Choice for You

If you cannot afford to overlook the tax deduction, the traditional IRA works just fine. If you can max out the $6,000 pre-tax contribution limit under a Roth IRA, then you will reap larger rewards in the future. One upside in all this is that the current changes to the Roth IRA involve an increase in income limits, which is a bonus if you’re a high-income earner.

Ultimately, at Masterworks, we want you to choose an investment plan that will get you an ideal retirement. We also welcome you to explore our blue-chip art investment, which is safe from volatility and offers great returns. We work with regular investors who want the experience of dabbling in multimillion artworks with minimal investment of $20 per share. Is this something you may be interested in? Fill in our membership application and start investing in your future.