Traditional IRA vs. Roth IRA Rules

The Traditional vs. Roth IRA decision shows up in portfolios as choosing the wrong account for your tax trajectory, missing contribution deadlines, and leaving money on the table through phaseout ignorance. In real market data, 35.1% of U.S. households own IRAs, but only 18.1% hold Roth accounts (Brady, 2012)—meaning most investors default to Traditional without analyzing which account maximizes their after-tax wealth. The practical antidote isn't picking one account forever. It's understanding the rules so you can optimize based on your current bracket, future expectations, and income level.

The Core Tradeoff (Tax Now vs. Tax Later)

Here's the fundamental decision:

Traditional IRA pathway: Tax deduction today (reduce taxable income) → Tax-deferred growth → Pay taxes on withdrawals

Roth IRA pathway: No deduction today (use after-tax dollars) → Tax-free growth → Tax-free withdrawals

The point is: if your tax rate stays constant, both accounts produce identical after-tax results (Burman, Gale & Weiner, 2001). The Roth wins when your tax rate rises; the Traditional wins when it falls.

A useful decision chain: Current tax bracket (input) → Expected retirement bracket (comparison) → Account selection (action) → Maximized after-tax wealth (outcome)

2025 Contribution Limits (The Numbers That Matter)

The IRS sets identical contribution limits for both account types (IRS Publication 590-A, 2025):

Critical rule: This is a combined limit across all IRAs. If you contribute $4,000 to a Traditional IRA, you can only contribute $3,000 to a Roth IRA that year.

Why this matters: Many investors don't realize they can split contributions between account types. If you're near a phaseout threshold, you might contribute to both accounts strategically.

Income Phaseouts (Where Rules Get Restrictive)

Roth IRA Income Limits (2025)

Direct Roth contributions phase out at higher incomes:

The calculation: If your modified adjusted gross income (MAGI) falls within the phaseout range, your contribution limit is reduced proportionally.

Example:

• Single filer with $157,500 MAGI (halfway through phaseout)
• Full limit: $7,000 x 50% = $3,500 maximum Roth contribution

Traditional IRA Deduction Limits (2025)

If you (or your spouse) have a workplace retirement plan, Traditional IRA deductions phase out:

The nuance (often missed): You can always contribute to a Traditional IRA regardless of income—you just can't deduct it above these thresholds. This creates the non-deductible Traditional IRA, which becomes the foundation for the backdoor Roth strategy.

Worked Example: When Roth Wins Big

Your situation: You're 25, earning $75,000 annually, in the 22% marginal bracket. You expect to earn more in retirement (pension + Social Security + withdrawals) putting you in a 25% bracket.

The calculation:

Traditional IRA path:

• Contribute $7,000 (tax-deductible, saves $1,540 today)
• Grows at 7% annually for 40 years
• Future value: $7,000 x (1.07)^40 = $104,914
• After 25% tax: $104,914 x 0.75 = $78,686 after-tax

Roth IRA path:

• Contribute $7,000 (no deduction—you pay $1,540 in tax today)
• Grows at 7% annually for 40 years
• Future value: $7,000 x (1.07)^40 = $104,914
• Tax owed: $0
• After-tax value: $104,914

Roth advantage on single year's contribution: $26,228

The durable lesson: Over a full career of maxed contributions, this tax rate difference compounds to $374,000+ in additional wealth (assuming consistent contributions and the 3-percentage-point bracket increase).

The Backdoor Roth (High Earner's Pathway)

If your income exceeds Roth phaseout limits, the backdoor Roth strategy provides access:

The mechanics:

1. Contribute to a non-deductible Traditional IRA (no income limits)
2. Convert immediately to Roth IRA (pay taxes only on growth—minimal if done quickly)
3. Result: Roth contribution through the back door

The pro-rata warning (critical): If you have existing pre-tax IRA balances, conversions become partially taxable. The IRS treats all your Traditional IRAs as one pool.

Example of pro-rata trap:

• Existing Traditional IRA: $93,000 (pre-tax)
• New non-deductible contribution: $7,000
• Total IRA balance: $100,000
• Pre-tax percentage: 93%
• If you convert $7,000 to Roth: $6,510 is taxable (93% of $7,000)

The practical antidote: Either roll existing Traditional IRA balances into a workplace 401(k) first (if allowed), or accept the tax hit as a one-time cost of Roth access.

Decision Framework (Which Account When)

Choose Roth IRA When:

• You're early in your career (low bracket now, higher later)
• You expect tax rates to rise generally
• You want tax-free withdrawals for estate planning
• You value flexibility (Roth contributions can be withdrawn anytime, tax-free)
• You're in the 12% or 22% bracket with room to grow

Choose Traditional IRA When:

• You're in a high bracket now (32%+) expecting lower in retirement
• You need the immediate tax deduction for cash flow
• You expect to retire to a low-tax state (Florida, Texas, Nevada)
• Your income will drop significantly in retirement
• You're near retirement with limited time for tax-free growth

Consider Both When:

• You're in the phaseout range for either account
• You want tax diversification (hedging against future policy changes)
• Your future tax rate is genuinely uncertain

The test: Project your retirement income sources. If pension + Social Security + Required Minimum Distributions from tax-deferred accounts push you into the same or higher bracket, Roth wins.

Detection Signals (Common Mistakes)

You're likely making an IRA mistake if:

• Your investment thesis is "Traditional is always better because of the deduction" (ignoring future tax rates)
• You can't articulate your expected retirement tax bracket (no projection exists)
• You're earning above phaseout limits but haven't implemented backdoor Roth (leaving money on the table)
• You use phrases like "I'll worry about taxes later" or "tax rates are unpredictable anyway" (abdicating analysis)
• You have large Traditional IRA balances but want backdoor Roth access (pro-rata trap waiting)

Next Step (Put This Into Practice)

Calculate your break-even tax rate. This tells you exactly what future bracket makes Traditional vs. Roth equivalent.

How to do it:

1. Note your current marginal tax rate (from your tax return)
2. Project your retirement income sources (Social Security estimate + pension + 4% of investment accounts)
3. Apply current tax brackets to that projected income
4. Compare current vs. projected rates

Interpretation:

• Projected rate higher: Roth wins—pay taxes now at the lower rate
• Projected rate lower: Traditional wins—defer taxes to the lower-rate years
• Rates roughly equal: Split contributions for tax diversification

Action: If you're under 40 and in the 22% bracket or lower, default to Roth unless you have specific evidence your retirement bracket will be lower. The optionality of tax-free withdrawals has significant value.

---

References

• Brady, P. (2012). The tax benefits and revenue costs of tax deferral. Investment Company Institute.
• Burman, L., Gale, W., & Weiner, D. (2001). The taxation of retirement saving: Choosing between front-loaded and back-loaded options. National Tax Journal, 54(3), 689-702.
• Internal Revenue Service. (2025). Publication 590-A: Contributions to Individual Retirement Arrangements (IRAs).