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“Should I contribute to a Traditional IRA or a Roth?” is a question I hear often.
And unfortunately, the answer is: it depends.

There are a few things to consider when deciding what type of Individual Retirement Account you should invest your money in. Below are the questions I ask my clients when deciding between a Traditional and a Roth IRA. 

How much money do you make? 

  • Roth IRAs have income limitations for contributions. That doesn’t mean you can’t have a Roth if you earn above the income limitation, it just means you can not directly invest your money into a Roth. Sufficiently confused? Check out my blog on Roth IRAs to learn about Back-Door Roths.
  • In 2021, singles must have an modified adjusted gross income (MAGI) of less than $140,000, with contributions being phased out starting with a MAGI of $125,000.
  • In 2021, married couples must have MAGIs of less than $208,000 to contribute to a Roth, and contributions are phased out starting at $198,000.
  • IRAs do not have income limitations for contributions.

Do you want to pay taxes now or later?

  • Traditional IRA contributions are tax-deductible on both state and federal tax returns for the year you make the contribution. Deductibility is dependent on income and if you qualify for an employer sponsored retirement plan. Because of that deduction, withdrawals are taxed at your income tax rate when you make them, presumably in retirement.
  • With Roth IRAs, you are paying your tax bill up front. You fund the account with after tax dollars, do not get that tax deduction, the account grows tax deferred and the withdrawals are tax free.

Do you want control over your distributions?

  • IRAs have mandatory distribution rules. Currently, Required Minimum Distributions (RMDs) are required starting at age 72. RMDs are a percentage of your IRA. The RMDs are taxed and required, whether you need the money or not.
  • Roth IRAs do not require minimum distributions. In fact, you do not have to withdraw money at all from your Roth IRA. Because of that, they are ideal wealth-transfer vehicles. Beneficiaries of Roth IRAs don’t owe income tax on withdrawals, but they are required to take distributions or roll the account into an IRA of their own.

Is there a chance you will need this money before retirement?

  • If you withdraw money from your IRA before age 59 ½, not only would you pay taxes on the withdrawal but you would also pay a 10% penalty on the distribution amount. 
  • You can avoid the penalty (but not the taxes) in certain circumstances. It is an option for qualified first-time home-buyer expenses (up to $10,000) or qualified higher education expenses.
  • Hardships, such as disability and certain levels of unreimbursed medical expenses, may also be exempt from the 10% penalty, but you’ll still pay taxes on the distribution.
  • You can always withdraw your Roth IRA contributions penalty free.

Bottom line, If you

  1. believe taxes are going to go up…
  2. think you will be in a higher tax bracket in retirement…
  3. like the idea of having tax free income in retirement…

….a Roth IRA may be the way to go.

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