When it comes to retirement saving, which is better for you: a Roth IRA or traditional IRA?

What are the differences between a Roth and a traditional IRA, anyway? Is one of them better for everyone in any circumstances? Or does it vary, depending on your circumstances?

The answers boil down to this: The best one for you is the one that leaves you more money after you’ve paid taxes, once you’ve retired and started to take withdrawals.

That bottom line depends on your situation — everything from your age to your salary, your pay raises over the years and your tax rate, now and in the future.

All of those factors come into play because a Roth IRA and a traditional IRA work slightly differently.

What’s The Difference Between A Roth IRA Vs. Traditional IRA?

With traditional accounts, the money you contribute does not count as part of your taxable income for that year. Basically, you get a tax deduction for those contributions.

Once contributions are inside your account, your money can grow — but without being taxed like other kinds of income. It is finally taxed when you withdraw money from the account, preferably in retirement. It’s taxed at whatever your ordinary income tax rate is that year.

In contrast, you do not get a deduction for your contribution to a Roth IRA. Money you sock away is money that is left over after you pay income tax on it.

Once it’s in the account, it grows tax-deferred like money in a traditional IRA.

How To Choose Roth IRA Vs. Traditional IRA

Why does it matter whether your money is taxed before or after going into your account? Because not all taxes are the same size.

If you expect your tax rate to stay the same or rise in retirement, then a Roth account is generally better for you.

“That’s the general guideline,” says Maria Bruno, head of the U.S. wealth planning research team at fund giant Vanguard. “For that reason, everything else being equal, for young workers who are in the early part of their careers, the advantage tips to Roths. That’s because their salary is likely relatively lower than it potentially will be later in their career or in retirement.”

Let’s say you’re a single guy or gal who earns $75,000 this year. Your marginal tax rate will be 24%.

Suppose you retire 45 years from now. Let’s say you’re still single but your income has climbed to $150,000. Even if Congress does not change today’s tax rates, your rate will be 32%. And you know Congress. Your tax rate and your bracket — the amount of taxable income it takes to reach any given rate level — are very likely to be pushed higher by then, thanks to Congress. So even the same $75,000 of income is probably going to be hit with a higher tax rate in 45 years.

Bottom line: You’re better off paying just 24% on your income today than paying 32% when you retire. That means you’re better off with a Roth IRA — and a Roth-style 401(k) account, if your plan offers them — than with traditional versions of those same accounts.

Roth Vs. Traditional IRA And Required Minimum Distributions

But what if you’re not young? What if you don’t have a lot of years before you retire? What if your tax rate is likely to be lower once you retire? “You may be better off with a traditional account,” Bruno said.

Still, the decision is not always either-or. With a traditional IRA and either a traditional or Roth 401(k), you must start taking withdrawals known as required minimum distributions, or RMDs, by April 1 of the year after you turn age 70-1/2.

A Roth IRA is exempt from RMDs.

If you inherit a traditional IRA, you must start to take withdrawals over your lifetime or within five years after the original account holder passed away, regardless of your age.

With either type of 401(k), if you’re still working, you can delay the start of RMDs until April 1 of the year after you retire.

That right to delay the start of RMDs does not apply if you own more than 5% of the company sponsoring the 401(k).

So, you may want to use a Roth account instead of a traditional one even if you think your tax rate will be the same in retirement. “RMDs can change the equation,” Bruno said. “The RMD could bump someone into a higher tax bracket. That could cause taxation of Social Security benefits (that otherwise would not be subject to taxation). It could also lead to other taxes.”

Bruno’s solution: even if you think you might be better off with a traditional account, consider using a Roth account too. “By using tax diversification, you may avoid unintended tax consequences,” Bruno said.

Can I Withdraw Money From My Roth IRA Without Penalty?

You can withdraw contributions to a Roth IRA anytime, free of taxes and penalties as well.

But your investment gains — your earnings — can be withdrawn tax- and penalty-free only if you’re over age 59-1/2 and your account has been open five years or more.

If you:

  • Haven’t had the account more than five years and haven’t reached age 59-1/2: Earnings you withdraw are taxable and subject to a 10% early-withdrawal penalty. Fortunately, there are exemptions from the penalty, but not tax, such as using up to $10,000 of it to buy a first-time home.
  • Haven’t had the account more than five years and are between the ages of 59-1/2 and 70: Earnings you withdraw are taxable but not subject to the penalty.
  • Have had the account less than five years and are 70-1/2 or older: Earnings you withdraw are taxable but not subject to penalty.
  • Have had the account more than five years and are 70-1/2 or older: Any withdrawals are tax- and penalty-free.

Can I Borrow From My Roth IRA?

Yes, and no. But mostly no. Unlike many 401(k) accounts, there is no rule that lets you take a loan from a Roth IRA or a traditional IRA. But, as explained above, you can withdraw your contributions to a Roth IRA at any time.

The potential pitfall concerns how you handle any money you “borrow.”

Many people, including financial advisors, mistakenly believe you are not allowed to put the money back into the same Roth IRA. Not true; you can use the same Roth IRA, said Vanguard’s Bruno.

The key is that whichever Roth IRA you put the money into, you must do it within 60 days. Keep it any longer and you’ll get socked with a 10% early withdrawal penalty.

Your investment gains are another story. As detailed above, those are subject to tax and early-withdrawal penalty if you’re not old enough and the account is not at least five years old. You can’t return earnings to another Roth IRA even if you do it within 60 days.

The situation is similar for a traditional IRA. Once you take any money out, you can avoid tax and penalty only if you return it to one of your IRAs within 60 days. If you don’t return the full amount that you withdrew into a new IRA, you’ll owe tax and possibly a penalty — unless you qualify for one of those exemptions we mentioned above.

You can only use this rollover tactic once every 12 months.

“Many people think it’s a calendar-year rule,” said Ed Slott, founder of IRAhelp.com. “It’s not. … You must wait a full year.”

Crux Of The Matter

The reason that you use any type of IRA or 401(k) account is to build a retirement nest egg by investing. If you want to learn how to put your money to work in the stock market via stocks, mutual funds, ETFs and other securities, check out IBD’s “How To Invest” page.

Also, if you want tips for maximizing your shot at a $1 million balance in your retirement account, heed the advice that experts share with IBD. Fidelity Investments 401(k) specialist Meghan Murphy recommends that you start saving early, save 15% of your pay and contribute enough to get the largest company match from your employer.

Above all, remember that any attempt to make money in the stock market starts with three common-sense steps, involving market trends, identifying the best stocks and planning your trades.