Are you wondering whether you should choose a Roth IRA or a savings account? There's really no competition. You need both as part of your long-term financial planning. They serve different purposes and, used strategically, can help you build long-term wealth. Learn the difference between a Roth IRA and a savings account here and how you can use both.
What Is a Roth IRA?
A Roth IRA is a tax-advantaged retirement account. It’s a special type of individual retirement account (IRA) where you pay taxes on contributions upfront, and then they grow tax-free.
That means that if you contribute $6,500 per year (about $541 per month) and invest those funds in an index-tracking fund that returns 10% per year, after 30 years you’ll have over $1 million with only $195,000 in contributions. That means you’ll earn over $800,000 tax-free.
As of 2023, you can contribute a maximum of $6,500 per year to a Roth IRA as an individual. This number increases to $7,500 if you’re 50 or older.
To contribute to a Roth IRA, you must earn less than $138,000 while filing taxes as an individual or $218,000 for married couples filing jointly for 2023. A backdoor Roth IRA could be an option if your income surpasses those limits.
With a backdoor Roth IRA, you'll invest in a traditional tax-deferred IRA before using a Roth conversion to move those funds into a Roth IRA. Speak to a financial adviser to understand the implications of this option and whether it will work for you.
You can withdraw your contributions (the principal) from a Roth IRA anytime. But you cannot withdraw the earnings before age 59½ without penalties or meeting special exceptions.
What Is a Savings Account?
A savings account is a bank account designed to store and grow funds over time. The benefits of a savings account are risk-free compound growth. Interest rates on savings accounts vary widely, from less than 0.01% to 5% on high-yield savings accounts.
Savings accounts are a safe place to store money and offer the flexibility to withdraw funds when needed. High-yield savings accounts are a secure place to store an emergency fund or to save for short-term goals like a mortgage down payment or a special vacation.
Comparing Roth IRAs and Savings Accounts
A Roth IRA and a savings account are popular financial tools for saving and growing money. They have different purposes and different pros and cons. Below is a comparison of the strengths and weaknesses of each.
Factor 1: Tax Considerations
Roth IRAs are specifically tax-advantaged accounts. You will get tax-free growth on Roth IRA contributions. You aren't required to take any distributions from a Roth IRA at retirement age, which means if you don't need the funds, they can continue to grow tax-free.
There aren't any tax deductions on contributions. But retirement withdrawals are tax-free, provided certain conditions are met. Roth IRA withdrawals are also tax-free for heirs, making it a tool to pass on generational wealth.
In contrast, savings accounts are taxable accounts. That means you’ll pay tax on the interest earned on savings accounts and all contributions to the savings accounts.
Factor 2: Contribution Limits and Accessibility
Roth IRAs have both an annual contribution limit as well as income limits. As of 2023, you can contribute a maximum of $6,500 per year or $7,500 if you’re 50 or older. You can only contribute to a Roth IRA if you earn less than $138,000 as an individual or $218,000 as a married couple filing jointly as of 2023.
In addition, you can only contribute earned income to a Roth IRA. That means you cannot add contributions if you have no earned income.
Potential penalties also exist. For early withdrawals of the income in a Roth IRA, you will be assessed a 10% additional tax on all early distributions (but not the principal).
For a savings account, there are no contribution limits or income limits. But savings accounts are only Federal Deposit Insurance Corp. (FDIC)-insured up to $250,000 per account holder or $500,000 total for joint account holders.
You can contribute all types of funds, including earned income, gifts or investment income, to a savings account. You can also choose to withdraw funds at any time without penalty, although some savings accounts limit withdrawals to a maximum of six per month.
Factor 3: Investment Options and Returns
A Roth IRA offers significant investment options and potential returns. With a Roth IRA, you have the flexibility to invest in a variety of assets, including stocks, bonds, mutual funds, indexed funds and exchange-traded funds.
In contrast, savings accounts don't allow you to invest funds and typically offer lower returns because of their conservative nature. With a savings account, you sacrifice higher returns for greater security.
Factor 4: Withdrawal Rules and Penalties
Withdrawal rules and potential penalties for a Roth IRA are more complex than savings accounts. First, you can withdraw the Roth IRA principal penalty-free. That means if you contribute $6,500 per year for 15 years, you could withdraw up to $97,500 penalty-free.
If you're older than 59½ and have had the Roth IRA for at least five years, you can withdraw contributions and earnings without taxes or penalties. If you're younger than 59½, you can make a withdrawal for special exceptions, like a first-time home purchase, college expenses, disability, certain medical expenses or other special situations.
If you don't meet exception requirements, you must pay a 10% additional tax on all early distributions. On the plus side, there are no required minimum distributions for Roth IRAs for the original account holder. Heirs who inherit a Roth IRA must take distributions.
You have unrestricted access to funds in a savings account, but you may have to pay bank fees, and your bank may limit the number of withdrawals you make each month.
Factor 5: Accessibility of Funds
Accessibility of funds in a Roth IRA is greater than a 401(k) or a traditional IRA but less than a savings account. With savings accounts, you can access funds at any time. With a Roth IRA, you can only access the principal penalty-free unless you meet certain exceptions.
Factor 6: Investment Growth Potential
Savings accounts don't have investment growth potential. In contrast, a Roth IRA allows you to invest contributions in stocks, bonds and mutual funds that offer higher growth potential than the interest earned in a savings account.
A well-diversified Roth IRA portfolio offers significantly more long-term growth potential than a savings account. It is one of the most important vehicles to build retirement wealth through investment.
Factor 7: Retirement Savings and Future Planning
Both a Roth IRA and a savings account offer long-term retirement planning potential. A Roth IRA is a dedicated retirement account that offers the greatest potential for long-term financial growth with tax advantages.
A savings account can serve multiple purposes, from saving for a vacation to saving for a mortgage. A high-yield savings account is a good place to store an emergency fund or up to six months of expenses. It isn't usually the best vehicle for retirement savings.
Final Thoughts on Roth IRA vs. Savings Account
Do you need a savings account or a Roth IRA? You need both. There is no debate about savings vs. IRA. A Roth IRA is one of the most powerful tools to build retirement wealth tax-free. After maximizing any available employer-matched 401(k), your retirement savings priority should be contributing to a Roth IRA.
A high-yield savings account is the place to store short-term savings and an emergency fund that you can access at any time. You can use the power of a Roth IRA and a savings account to build a robust financial plan for both short-term and long-term financial goals.
Frequently Asked Questions
Can I withdraw money from a Roth IRA like a savings account?
You can withdraw the principal contributed to a Roth IRA. A Roth IRA doesn’t allow penalty-free withdrawals on the interest or growth like a savings account.
Can funds be withdrawn from a Roth IRA or a savings account before retirement?
Yes, funds can be withdrawn from a traditional savings account at any time. You can also withdraw the principal from a Roth IRA at any time. You cannot withdraw the earnings penalty-free unless you meet certain criteria.
Can I contribute to both a Roth IRA and a savings account?
Yes, you can contribute to both a Roth IRA and a savings account. It’s a good idea to have both and keep them for different purposes.
About Alison Plaut
Alison Plaut is a personal finance writer with a sustainable MBA, passionate about helping people learn more about financial basics for wealth building and financial freedom. She has more than 17 years of writing experience, focused on real estate and mortgage, business, personal finance, and investing. Her work has been published in The Motley Fool, MoneyLion, and she is a regular contributor for Benzinga.