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ST. CROIX INSIGHTS

Roth IRA vs. Traditional IRA: What’s the Difference?

BY BRETT ANDERSON/ST.CROIX ADVISORS, LLC
Roth IRA vs. Traditional IRA

First off, pay now or pay later—that is the question. Ordinarily, when we discuss the difference, most individuals generally point out the fact that they’ll be in a lower tax bracket come retirement. However, I’m 99% confident that this is probably not the case for most of us.

Remember, our government needs and wants your money. In short, a host of factors will ultimately decide your tax rate at retirement, the two biggest of which are health and lifestyle in your golden years.

Although we can run the math a thousand ways, the biggest question to ask is: Do you want all of your income in retirement taxed? The answer is often no.

Here’s a list of some of the differences between two of the most common retirement accounts: the Roth IRA and the Traditional IRA account. If you have specific questions, please don’t hesitate to contact us.

The Difference Between a Roth IRA and Traditional IRA

Roth IRA

  • Eligibility: Individuals must have taxable compensation, or a spouse with earned income if filing jointly. Contributions are not subject to age requirements.
  • Tax Treatment: Contributions are not tax-deductible and are subject to modified adjusted gross income (MAGI) limitations.
  • Contribution Limits for 2024 and 2025:
    • Individuals under age 50 can contribute up to $7,000.
    • Individuals aged 50 and older can contribute up to $8,000, including a $1,000 catch-up contribution.
    • Note: The total contribution to all IRAs (Roth and Traditional) cannot exceed these limits.
  • Income Limits for 2024:
    • Single Filers:
      • Full contribution allowed if MAGI is less than $146,000.
      • Contribution limit phases out between $146,000 and $161,000.
      • No contribution allowed if MAGI is $161,000 or more. Time to consider Backdoor Roth.
    • Married Filing Jointly:
      • Full contribution allowed if MAGI is less than $230,000.
      • Contribution limit phases out between $230,000 and $240,000.
      • No contribution allowed if MAGI is $240,000 or more. Time to consider Backdoor Roth.
  • Income Limits for 2025:
    • Single Filers:
      • Full contribution allowed if MAGI is less than $150,000.
      • Contribution limit phases out between $150,000 and $165,000.
      • No contribution allowed if MAGI is $165,000 or more. Time to consider Backdoor Roth.
    • Married Filing Jointly:
      • Full contribution allowed if MAGI is less than $236,000.
      • Contribution limit phases out between $236,000 and $246,000.
  • No contribution allowed if MAGI is $246,000 or more. Time to consider Backdoor Roth.
  • Distributions:
  • Best Practices:
    • To maximize tax benefits, keep funds in the account for at least five years and wait until age 59½ before taking distributions.
    • Withdrawals before meeting these criteria may incur a 10% tax on earnings.

Note: Be aware of the 5-year tax rule for Roth plans.

Once you open a Roth IRA, you need to wait five years after your first contribution to withdraw funds tax-free. January 1 of the first year you contribute begins the five-year countdown. For example, if you make your first contribution on March 1, 2025 the five-taxable-year period starts January 1, 2025 and ends December 31, 2030.

Failing to meet the five-year rule means earnings could be subject to income taxes and possibly a 10% early withdrawal penalty if other qualifying criteria (like age 59½) aren’t met.

This rule applies for conversions as well. If you convert funds from a Traditional IRA to a Roth IRA, a separate five-year period applies for the converted amount. Each conversion has its own five-year clock, starting on January 1 of the year the conversion is made.

Traditional IRA

  • Eligibility: Individuals must have earned income, or a spouse with earned income if filing jointly.
  • Tax Treatment:
    • Contributions are generally tax-deductible.
    • Deductibility phases out if the contributor or spouse participates in an employer-sponsored retirement plan and the household income exceeds IRS thresholds.
  • Contribution Limits for 2024 and 2025:
    • Individuals under age 50 can contribute up to $7,000.
    • Individuals aged 50 and older can contribute up to $8,000, including a $1,000 catch-up contribution.
  • Distributions:
    • Withdrawals before age 59½ are subject to a 10% early withdrawal penalty unless meeting specific exceptions, such as death, disability, qualifying education expenses, medical expenses, or first-time home purchases.
    • Required minimum distributions (RMDs) must begin at age 73, regardless of whether you need the funds, potentially impacting your tax situation.

Choosing Between a Roth and Traditional IRA

Deciding between a Roth IRA and a Traditional IRA depends on your current financial situation, expected tax rate in retirement, and long-term goals. Consulting with a skilled financial planner can help you make the best decisions for your situation. Call St. Croix Advisors at (651) 337-1919 or (877) 393-1919 or email info@stcroixadvisors.com for more information.