Your First IRA: Is Roth or Traditional the Best Way to Go?

If you're starting your first job or are still relatively young, starting to save for your retirement or increasing your retirement savings is perhaps the smartest financial decision you can possibly make. The long-term compounding power you have could transform seemingly small amounts of money into a large retirement nest egg down the road.

One of the best ways to invest for retirement is through an IRA, but there are two types -- traditional and Roth. Here's a quick guide that can help first-timers decide which variety of IRA is the best way to go.

What is an IRA and why should you use one?

An IRA, which stands for "individual retirement arrangement (or account)," is a tax-advantaged savings vehicle designed to help Americans save and invest money for retirement. IRAs come in two main varieties -- traditional and Roth -- and we'll discuss the differences later on.

With either type of IRA, eligible savers can contribute a maximum of $5,500 for 2018 ($6,500 if 50 or older). Once money is contributed, it can be invested in stocks, bonds, mutual funds, ETFs, and many other options. It can also be left in cash or equivalents if desired. And you may be able to invest in an IRA in addition to an employer's retirement plan such as a 401(k).

Generally speaking, you can't withdraw from your IRA until you reach 59 1/2 years of age, but there are a few exceptions. For example, there's a big Roth IRA early withdrawal exception that I'll get into during the Roth discussion, and IRA funds may be able to be used early for college expenses or for a first-time home purchase (up to $10,000) without penalty.

The key takeaway so far is that the tax-advantaged nature of IRAs can allow you to amass significantly more retirement wealth than you could if you were investing in a standard (taxable) brokerage account. Now, we'll get into the differences between traditional and Roth IRAs.

Benefits of a traditional IRA

The main difference between traditional and Roth IRAs is their respective tax treatment, so let's start with the traditional IRA.

Traditional IRA contributions are generally made on a tax-deferred basis. This means that the money you put in may be eligible for a current-year tax deduction and can grow and compound without dividend or capital gains taxes while the funds remain in the account. When you eventually withdraw money from your traditional IRA, however, it will be treated as taxable income. In a nutshell, a traditional IRA can give you a big tax break now.

It's also important to point out that I said you "may be" eligible for a tax deduction. Anyone can contribute to a traditional IRA, but the ability to take advantage of the tax deduction is income-restricted. If you have access to a retirement plan at work, here are the 2018 income limits for the traditional IRA deduction:

Tax Filing Status

2018 Traditional IRA
Full Deduction AGI Limit

Phase-Out Limit for Partial Deduction

Single or Head of Household



Married Filing Jointly



Married Filing Separately



On the other hand, if you don't have a retirement plan at work, your ability to take the deduction is only limited if your spouse has a retirement plan available at their job. In this case, the income thresholds are:

Tax Filing Status

2018 Traditional IRA
Full Deduction AGI Limit

Phase-Out Limit

Married Filing Jointly



Married Filing Separately



Roth IRAs have some unique perks

Unlike a traditional IRA, Roth IRA contributions are never tax-deductible. However, money in the account can grow and compound without dividend or capital gains taxes, and qualified withdrawals will be 100% tax-free. So, while a traditional IRA gives you an immediate tax benefit, a Roth IRA lets you pay taxes now with the goal of creating a source of tax-free income later in life.

In addition to the tax benefits, there are a few other key perks to investing with a Roth IRA that don't apply to traditional IRAs.

First and foremost, because you've already paid taxes on the money you contribute, you can withdraw your contributions (but not any investment earnings) at any time, and for any reason, without paying an early withdrawal penalty to the IRS. Furthermore, there is no maximum age to contribute to a Roth IRA, nor is there a minimum distribution requirement once you reach a certain age.

The ability to contribute directly to a Roth IRA is income-restricted. For 2018, your income must conform to these limitations to be able to put money into a Roth IRA:

If you don't meet the income qualifications, you still may be able to contribute via the so-called backdoor method. Essentially, this means contributing to a traditional IRA and then immediately converting the account to a Roth.

Which is best for you?

The best choice for you depends on your individual circumstances. From a purely tax-motivated perspective, a traditional IRA makes more sense for someone with a relatively high income now who is likely to be in a lower tax bracket after retirement. On the other hand, a Roth IRA makes the most sense for savers with relatively low incomes who aren't going to pay much taxes on their contributions.

As a personal example, I used a Roth IRA for a few years after college when I was a new high school teacher, but then as my income started to rise a bit, I shifted to the traditional route.

Having said that, some of the other perks of a Roth IRA should be taken into consideration -- specifically the ability to withdraw contributions at any time. If your least-favorite thing about retirement saving is tying up your money for decades, a Roth could be the best choice.

As I said, it all depends on your income level and personal preferences. As long as you qualify for the tax benefits of each, you won't go wrong with either option, but by weighing the benefits of each, you can make the best possible choice for you (and for your future self as well).

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