Roth IRA vs. Traditional IRA: Tax Implications Explained

Tax Strategies | by Jules Buxbaum | Sunday, February 02, 2025

Roth IRA vs. Traditional IRA decisions matter for anyone who wants a smart retirement strategy. Many individuals, including first-time savers and experienced investors, wonder which account will reliably reduce their tax bills over time.

If you’re looking for additional clarity on selecting the right option for your future, check out our detailed guide on how to choose between Roth IRA and Traditional IRA. This comparison steers you toward a better fit based on your current income, tax expectations, and retirement goals.

Key Differences in Tax Treatment

A Traditional IRA often lowers your taxable income for the year you contribute. You add funds with pre-tax dollars, which may trigger an immediate tax break.

By contrast, a Roth IRA works with after-tax contributions. You don’t get a deduction right away, but your qualified withdrawals in retirement are not taxed.

This distinction prompts many people to consider their future tax bracket. If you think taxes might be higher when you retire, Roth contributions could help you lock in tax-free income later.

Understanding Contribution Limits and Income Levels

For the 2025 tax year, the total IRA contribution limit is $7,000 if you’re under 50. It’s $8,000 if you’re 50 or older, thanks to a $1,000 catch-up.

Roth IRA contributions start phasing out at $150,000 of MAGI if you file singly. For married couples filing jointly, the phase-out climbs to $236,000.

Meanwhile, Traditional IRA deductibility follows its own thresholds. If you’re covered by a workplace plan and file jointly, your full deduction starts to phase out at around $126,000 of MAGI.

The Power of Tax-Free versus Tax-Deferred Growth

Traditional IRAs deliver tax-deferred growth. You avoid taxes on gains until withdrawals, but you’ll pay ordinary income tax once you start tapping that money.

Roth IRAs grant tax-free growth. Once you’ve held the account for at least five years and pass age 59½, you owe no taxes on withdrawals of contributions or earnings.

Having both types of IRAs diversifies your future tax flexibility. According to a 2022 Fidelity study, retirees who balanced pre-tax and Roth accounts saved an average of $100,000 in lifetime tax costs compared to those who relied on only pre-tax funds.

RMDs and Retirement Planning Nuances

Traditional IRAs have Required Minimum Distributions (RMDs) starting at age 73 for most people born after June 30, 1949. In 2033, that starting age moves to 75.

Roth IRAs do not impose RMDs during your lifetime. If you’d like to keep assets growing for as long as possible, a Roth is attractive for avoiding forced withdrawals.

For more details on mandated withdrawals, read our resource on Understanding Required Minimum Distributions (RMDs). It clarifies key steps so you can plan your retirement timeline properly.

Rethinking Conventional Wisdom about Risk

Many retirement investors believe they must lower equity exposure with age. However, 2Pi Financial’s perspective is that risk allocation depends more on future earnings relative to current wealth.

If your future income stream is large compared to your assets, you could absorb more stock market risk, even later in life. Conversely, a younger person with limited future earnings may need a more cautious approach.

The intent is to highlight that age is not the major factor. Instead, focus on your unique blend of monthly inflows, future salaries, savings goals, and planned retirement date.

Tax Considerations for IRA Conversions

Moving Traditional IRA balances into a Roth IRA, known as a Roth conversion, can be a useful strategy, but it creates a taxable event. You’ll pay income tax on the converted amount in the year it occurs, which might affect other items like Social Security taxation.

That said, well-timed partial conversions can be helpful during years when your marginal rate is lower, such as early retirement or periods of reduced income. Spreading conversions across multiple tax years can make a difference in how big a bill you face each year.

Plan carefully if you use this approach. Unexpected taxes can appear if you overlook extra income from IRA conversions, especially if it bumps you into a higher bracket.

Social Security and State Tax Factors

If you withdraw from a Traditional IRA, it generally increases your taxable income in retirement. This could push a larger portion of your Social Security benefits into a taxable range.

In contrast, Roth IRA withdrawals do not affect Social Security calculations. Some states, including Florida, don’t tax personal income at all, making Roth money even more appealing for eventual use in such states.

Taxes can fluctuate drastically from one area to another, so consider relocating or focusing on a state with favorable retirement rules. Everyone’s situation is different, so weigh state-specific guidelines alongside your overall plan.

Why 2Pi Financial Emphasizes Individualized Strategies

At 2Pi Financial, our data-driven approach weighs factors like future earnings, equity risk premiums, and your current wealth. We strive to help professional service sales teams and individual investors build retirement plans that don’t rely strictly on age-based formulas.

Historically, equities have outperformed other major asset classes, yet many retirees hold overly low equity positions. We see no inherent reason to expect this strong performance trend to collapse, making it important to calibrate your holdings properly.

To see how our Financial Planning Engine addresses complex decisions like Roth versus Traditional IRA, risk allocations, and how to handle required distributions, take a look at our Two Pi Financial Planner. Input your details, adjust your risk tolerance, and get a plan that’s dynamically updated over time.

Strategies to Minimize Tax Burdens

Balancing account types is a direct way to keep future taxes under control. Tapping into a Traditional IRA might work well in some years, while leaning on Roth funds can lower your taxable income in others.

You’ll also want to check out our tips on how to minimize taxes on your retirement income. Even small choices, like the order in which you withdraw from different buckets, can alter your overall tax bill.

Also, look into deducing if a partial Roth conversion each year makes sense once you hit retirement. This move could temper your overall tax hit over decades.

What This Means for You

Choosing between a Roth IRA and a Traditional IRA means looking beyond present tax benefits. Plan for your ideal scenario based on future earnings, current savings, and where you expect your tax bracket to land when you retire.

For those seeking further guidance, feel free to explore our piece on how to set up a tax-efficient withdrawal strategy. This resource ensures your decisions create lasting benefits when you stop working.

Both IRA types have strengths, but personalization is vital. Don’t hesitate to combine both, examine partial conversions, and consider advanced planning to get a balanced foundation for your golden years.

References

1. TIAA Institute. (2022). “Understanding RMD Age Requirements.” Available at: https://www.tiaainstitute.org/understanding-rmd-age-requirements(#)

2. Fidelity. (2022). “Tax Diversification in Retirement.” Available at: https://www.fidelity.com/tax-diversification-in-retirement(#)