Roth IRA vs. savings account: Which is right for you?

With the ability to take out tax-free withdrawals in retirement, a Roth individual retirement account (IRA) can be a great tool if you're looking to put your money away for the long term. But is it better than a regular savings account if you prioritize stability?

Here are the differences between a Roth IRA vs. savings account so you can choose which best fits your needs. Hint: the answer may be both.

A savings account is available through credit unions and banks. You can deposit after-tax money into this account that you can later access through a withdrawal. In most cases, the institution pays you interest based on the amount of funds you leave in the account and the prevailing interest rates at the time. The interest earned is considered taxable income.

While a savings account can be used for any purchase, Roth IRAs are designed for saving for retirement. You contribute after-tax dollars and you can access your contribution dollars anytime. The earnings are distributed tax-free after you own the account for at least five years and you reach age 59½ or for a first-time home purchase ($10,000 limit), disability or paid to a beneficiary.

IRAs allow you to allocate your money into a variety of banking and investment products. Some banks, for example, offer savings IRAs that provide the stability of a certificate of deposit (CD) or money market account; the latter offers slightly higher yields than traditional savings accounts but typically requires higher minimum balances. Conversely, investment IRAs allow you to steer your money into securities such as mutual funds, annuities or individual stocks and bonds.

Though both a savings account and a Roth IRA are designed to help you save money for the future, they have a few key differences: IRAs have contribution limits and aren't as flexible as savings accounts.

The beauty of a savings account is that you can put in as much as you desire; that's not the case with Roth IRAs. For 2023, you're allowed to contribute up to $6,500, or $7,500 if you're age 50 or older (although you can't contribute more than you earned that year).

What's more, your income can't exceed IRS thresholds. For 2023, your contribution limits start to phase out if your modified adjusted gross income (MAGI) is:

• $138,000-$153,000, for single taxpayers and heads of household
• $218,000-$228,000, for married couples filing a joint return
• $0 to $10,000, for married couples filing a separate return

Another advantage of savings accounts is that you can typically pull your money out at any time without penalty. Historically, savings accounts had a limitation on the number of withdrawals you could make each month at six, though during the pandemic the Federal Reserve lifted that limitation. As of now, many banks will allow you to make withdrawals at any time, though this may change again in the future.

Roth IRAs, on the other hand, contain incentives for you to keep your assets in place. You can pull your contributions out anytime without incurring any tax consequences (they've already been taxed). However, an early distribution that contains earnings—say, the appreciation of your stock holdings—may be subject to ordinary income tax and a 10% penalty.

There are some exceptions to that rule, however. For example, if you've owned the Roth IRA for at least five years, you can take out up to $10,000 to purchase your first home without having to pay tax or a penalty. You also can sidestep the penalty when you withdraw funds for qualified higher education expenses like books, fees, tuition and equipment, although you'll have to pay income tax on any earnings. Contributions are distributed first.

Most financial institutions that offer savings accounts are federally insured, making them a safe place to keep your money. The Federal Deposit Insurance Corporation (FDIC) protects accounts at participating banks, and the National Credit Union Administration (NCUA) safeguards deposits at most credit unions. The two insurance programs work in a similar way, offering $250,000 per person, per bank or credit union, for each account ownership type.

Suppose you have $100,000 in an insured savings account at a bank. Should your institution become insolvent, the FDIC would step in and replace those funds.

Roth IRAs that contain savings accounts and CDs are typically FDIC- or NCUA-insured (though it's important to check first). However, the same protection doesn't extend to the portion of your IRA containing insurance and investment products. Securities can fluctuate in value in any given year, as can certain insurance products pegged to the performance of the stock market. This makes stocks and mutual funds, for example, a more appropriate option for long-term investors who can ride out temporary bumps along the way.

The security that savings accounts provide comes with a downside: modest returns. Even most online banks offering high-yield savings accounts have paid less than 1% annual interest on balances over the past year. One-year CDs are in the same territory. That return could increase if general interest rates climb, although you'll still face modest payouts.

Conversely, when you invest in stocks, bonds and mutual funds through a Roth IRA, you have the potential for much higher asset growth over periods of several years or more. Historically, the stock market has delivered an average return of roughly 10% a year, for example. Even Treasury bonds, which are backed by the full faith and credit of the U.S. government, generally offer a higher yield than savings accounts.

Choosing between a Roth IRA vs. savings account depends on your objectives.

• If you need to access funds within a relatively short timeframe, savings accounts offer the security and flexibility you may need. This makes them ideal for your emergency fund, for instance, or for money you plan to put down on a home in less than five years. In truth, many decide to use both financial tools, and open a savings account as well as a Roth IRA.

• You're usually better off using Roth IRAs for their intended purpose: retirement savings. By offering tax-free withdrawals after you own the account for five years and are age 59½, they're an ideal way to invest in funds and individual securities that can potentially grow over several years.

Connect with a Thrivent financial advisor for more personalized advice about which type of savings tool is right for your situation or what you could do with both accounts.