Traditional vs. Roth IRAs: What SMB Owners Must Know

What are the differences between traditional and Roth IRAs?

Understanding the nuances of traditional and Roth IRAs is crucial for building a robust retirement nest egg and choosing the right option for your needs and goals. 

“The differences between a traditional and Roth IRA are regarding the tax benefits, age and income requirements and withdrawal,” explained Alissa Todd, a financial advisor at The Wealth Consulting Group. These differences are not necessarily pros or cons, Todd noted. “What could be a pro for one investor may be a con for another, so it really depends on each person’s financial situation and goal.”

More specifically, the traditional vs. Roth IRA choice comes down to three questions:

• Do you want to pay taxes on your retirement account now or in retirement? If later, you may prefer traditional IRAs. If you prefer to pay taxes now, the Roth IRA is the better option.
• Do you have a high modified adjusted gross income (MAGI)? If so, you may only qualify for traditional IRAs.
• Do you want to have the option of withdrawing funds before retirement? If you want to make early withdrawals, you may prefer Roth IRAs. If you don’t plan to withdraw from your account until you retire, a traditional IRA is likely the right choice for you.

Traditional vs. Roth IRAs at a glance

Here’s a quick reference guide to traditional vs. Roth IRAs:

What are the contribution limits of Roth and traditional IRAs?

Both Roth and traditional IRAs have annual contribution limits, which may hinder your ability to save enough for retirement if a single Roth or traditional IRA is your only investment strategy. For 2024, you can contribute up to $7,000 to all your IRAs combined ($8,000 if you’re 50 or older). This limit applies to both traditional and Roth IRAs.

What are the income requirements for Roth and traditional IRAs?

Roth and traditional IRAs have different income requirements: 

• Roth IRA income requirements: Eligibility is based on your modified adjusted gross income. After you pass a certain income level, you may not be eligible to contribute to a Roth IRA. In 2024, single tax filers with MAGIs below $161,000 qualify for Roth IRA plans. This figure is up from 2022’s $144,000. Similarly, the MAGI limit for married couples filing jointly has also increased. In 2024, this limit is $240,000, up from $214,000 in 2022.
• Traditional IRA income requirements: Contributions are not limited by your income, and you may be able to open a traditional IRA for a spouse who does not work. However, in either case, the IRA contribution amount you can deduct from your taxes may be limited by your income.

What are the age limits for Roth and traditional IRAs?

Age limit rules are similar for Roth and traditional IRAs:

• Roth IRA age limits: You can contribute to a Roth IRA at any age as long as you meet the MAGI requirements.
• Traditional IRA age limits: As with a Roth IRA, you can contribute to your retirement account at any age, but this development is relatively new for traditional IRAs. Prior to 2020, the IRS restricted people over the age of 70 1/2 from contributing to their traditional IRAs.

What are the tax benefits of Roth and traditional IRAs?

There are significant differences between the tax benefits and structures of Roth and traditional IRAs.

Roth IRA tax benefits

Contributions to a Roth IRA are made with post-tax income. “However, when you withdraw money from a Roth IRA, it comes out tax-free as long as you meet the guidelines,” Todd explained.

The Roth IRA tax structure means you can’t directly deduct any Roth IRA contributions on your taxes. However, you may qualify for the retirement savings contributions credit, also known as the saver’s credit. You qualify if you meet the following requirements:

• You are at least 18 years old.
• You are not claimed as a dependent on another taxpayer’s return.
• You are not enrolled as a full-time university student or in full-time, on-farm schooling or government training courses during any part of five months of the calendar year.

The saver’s credit is calculated as a percentage of your eligible contributions. For 2024, the saver’s credit has the following rates:

• Maximum credit: $1,000 for single filers and $2,000 for joint filers.
• 50 percent of eligible contributions: For taxpayers with an AGI of $23,000 or below (single) or $46,000 or below (married filing jointly).
• 20 percent of contributions: For taxpayers with an AGI above the 50 percent threshold but below $25,000 (single) or $50,000 (married filing jointly).
• 10 percent of contributions: For taxpayers with an AGI above the 20 percent threshold but below $38,250 (single) or $76,500 (married filing jointly).

To qualify for the saver’s credit, you must contribute to a qualifying retirement account such as a traditional or Roth IRA, 401(k) or similar plan and meet the income eligibility requirements.

If your income exceeds the amounts outlined in the 10 percent bracket, you cannot claim the saver’s credit. You have until the personal income tax filing deadline to make your IRA contribution for the previous year if you want the deduction.

Traditional IRA tax benefits

Because contributions to traditional IRAs are made pretax, you can partially or completely deduct contributions from your taxes. However, you will have to pay taxes in retirement. “When you withdraw money from a traditional IRA, all distributions are taxed as ordinary income,” Todd noted. 

To determine whether you can partially or completely deduct your traditional IRA contributions from your taxes, see the below 2024 IRS traditional IRA deduction guidelines:

• Single with no employer-sponsored retirement plan: If you’re a single taxpayer, head of household or a qualifying widow(er) and are not covered by a retirement account at work, IRA contributions are completely deductible, regardless of income.
• Single with an employer-sponsored retirement plan: If you’re a single taxpayer or head of household and are covered by a retirement plan at work:
  • IRA contributions are completely deductible if your MAGI is less than $77,000.
  • IRA contributions are partially deductible if you make more than $77,000 but less than $87,000.
  • There’s no deduction if your MAGI exceeds $87,000.
• Married filing jointly with no employer-sponsored plan: IRA contributions are completely deductible for married couples filing jointly or separately, regardless of income, when neither spouse is covered by a retirement plan at work.
• Married filing jointly with an employer-sponsored plan: If you’re a married taxpayer filing jointly (or a qualifying widow or widower) and you’re covered by a retirement plan at work:
  • IRA contributions are completely deductible if your MAGI is $123,000 or less.
  • IRA contributions are partially deductible if you make between $123,000 and $143,000.
  • If your income exceeds $143,000, no deduction is possible.
• Married filing jointly when your spouse is covered: If you’re a married taxpayer filing jointly and your spouse is covered by a retirement plan at work:
  • IRA contributions are completely deductible only if the MAGI is $230,000 or less. 
  • IRA contributions are partially deductible if you make more than $230,000 but less than $240,000. 
  • If the MAGI is over $240,000, there is no deduction.
• Married filing separately with coverage: If you’re a married person filing separately and either partner is covered by a retirement plan at work, you can claim a partial deduction if your MAGI is below $10,000. Otherwise, no deduction is possible.

The saver’s credit also applies to traditional IRAs.

What are the withdrawal and distribution rules for Roth and traditional IRAs?

Note the following withdrawal and distribution rules: 

• Roth IRA withdrawals and distributions: You can withdraw money from a Roth IRA at any time without tax penalties. Additionally, as the account owner of your Roth IRA, you have no required minimum distribution. This means you’re never required to withdraw money, though any beneficiaries you designate might face this requirement.
• Traditional IRA: Withdrawals from a traditional IRA become tax-free at age 59.5. Account owners and beneficiaries alike must begin withdrawing from traditional IRAs once they turn 72.

What’s the right IRA for a small business owner?

Choosing the correct IRA for your retirement savings depends on several factors.

“The benefit of a Roth IRA is that … withdrawals are not taxable; withdrawals don’t impact Social Security [or] Medicare taxes,” said Ilene Davis, Certified Financial Planner and author of Wealthy By Choice: Choosing Your Way to a Wealthier Future. “However, there is no guarantee that withdrawals will not be taxed in the future … My general rule is that if a client is in the 22 percent or more tax bracket and can qualify for a traditional IRA, they should take the tax breaks now.”

If neither the traditional nor Roth IRA seems like the best option for you, speak to a financial advisor about other retirement plan options available to business owners, including a Savings Incentive Match PLan for Employees (SIMPLE) IRA, Simplified Employee Pension (SEP) IRA, solo 401(k) or 7702 plan. These plans often allow you to contribute more than you would in a traditional or Roth IRA, though there are more eligibility requirements.

“In a SEP IRA, you can contribute 20 percent of your earnings as a sole proprietor or 25 percent as an S- or C-corp up to $56,000, which is significantly higher [than a traditional or Roth IRA],” Todd said. “Ask yourself how much you can comfortably contribute into a retirement plan without putting yourself in a tight cash flow position.”

No matter what type of plan you choose, Davis says the best thing any small or midsize business owner can do to plan for retirement is to start saving as soon as possible.

“Find the type of plan that best suits your financial situation and needs and start,” Davis advised. “Don’t stop with tax-deductible or tax-advantaged plans if you can afford to invest more and still enjoy life. Often, the difference between an OK retirement and a great one is the wealth accumulated beyond retirement plans.”

How does an IRA differ from a 401(k)?

Both IRAs and 401(k)s are retirement savings accounts, but there are some key differences. A 401(k) retirement plan is an employer-sponsored plan, while an individual establishes an IRA without an employer’s involvement.

In some cases, employers will match employee contributions to their 401(k) as an employee benefit. Having a 401(k) plan at work impacts how much of a taxpayer’s IRA contributions are deductible.

IRAs are available to people regardless of employment status and can be set up by business owners, self-employed individuals and those without a traditional job. Distributions in retirement are tax-free for Roth IRAs but taxable for 401(k)s and traditional IRAs. 

IRAs and 401(k)s are both investment accounts, usually with investments in mutual funds or stocks. Their value can fluctuate depending on the market and individual investments.

Mike Berner and Jennifer Dublino contributed to this article. Source interviews were conducted for a previous version of this article.