Investing in retirement accounts outside of your employer-provided 401(k) can have several advantages:
- Increased freedom in asset options
- Potential for larger earnings
- Savings beyond your employer matched 401(k) contributions
For most investors, saving and investing through individual retirement accounts (IRAs) gives the opportunity for more freedom both in the assets they invest in as well as how their savings are taxed. The two most common accounts are the Traditional IRA and Roth IRA.
Key Differences Between Traditional & Roth IRAs
While both Traditional and Roth IRAs can help you save for retirement and reach your financial goals, they have some benefits which are specific to each account type. You can learn more about Traditional and Roth IRAs with Matisse, but in general, these are the key differences:
| Roth | Traditional | |
|---|---|---|
| Contributions | After taxes | Pre-tax, like a 401(k) |
| Best suited for | An investor who thinks that they will continue to grow their income and be in a higher tax bracket when they retire | An investor who doesn't expect to be in a higher tax bracket when they retire |
| Taxes | ||
| Earnings on contributions | Tax-free | Tax-deferred |
| Tax Benefits | Not deductible and gives you no current-year tax benefits | Contributions are tax-deductable (some limitations for investors with employer-sponsored plans) and give immediate tax benefits |
| Contributions | ||
| Contributions made from | After tax income | Pre- or after-tax income |
| Maximum Contribution (2024) | $7,000 ($8,000 for investors over age 50) | $7,000 ($8,000 for investors over age 50) |
| Eligibility | Investors with income below a certain level | Anyone with earned income |
| Age Restrictions | None | None |
| Withdrawals | ||
| Penalties | After 5 years and over the age of 59 1/2 withdrawals are penalty- and tax-free | After the age of 59 1/2 withdrawals are penalty-free and taxed as current income |
| Mandatory Distributions | None | After the age of 73 |
Retirement Saving Strategies
For most investors, the decision on which account is best for them will depend on where they are relative to their retirement goal. For instance, since a Roth IRA’s earnings are tax-exempt when withdrawn during retirement (or over the age of 59 and 1/2), it typically makes sense for younger investors who expect to be making more money later in life to choose to contribute to this IRA. By opting to tax contributions as income now, when their tax rates may be lower than in the future, they can potentially pay fewer taxes on their savings overall.
But for investors saving for retirement later in life, when they are likely closer to their peak income years, it may make more sense to contribute to a Traditional IRA. Their contributions will be tax-exempt in the immediate tax year, but their withdrawals in the future will be taxed as current income. This means that if they are planning to hold the account and not withdraw until later in retirement when their income is lower than it is now, they may see more tax benefits than with a Roth IRA.
Combining Traditional and Roth IRAs
Investors may want to have both Traditional and Roth IRAs to contribute to in the long term, or even concurrently. While contributions share limits — meaning you can still only contribute the same amount, even if split between the two accounts — this can help investors “hedge their bet” if they’re unsure of what their income will look like when they withdraw the funds during retirement.
Additionally, having both accounts could be advantageous and allow investors to quickly switch from Roth contributions to Traditional contributions if they feel they’ve reached close to their peak income.
For investors who are self-employed, this also has the potential benefit of allowing them to switch back and forth between Traditional and Roth IRA contributions year-to-year, based on fluctuations in their income.
Interested in opening either a Traditional or Roth IRA? Visit our Retirement Accounts page to learn how to apply for an account with Matisse.