Traditional IRA vs. Roth IRA: Which is Best for You?

Saving for retirement shouldn’t be complicated, but with so many retirement savings options, from 401ks to IRAs and more, knowing the best way to save can be confusing. How much you make, whether you’re self-employed or have a company-sponsored retirement plan are just some of the criteria that will determine what solution is best for you.

One question that seems to come up again and again is “What’s the difference between an IRA and a Roth IRA?” It’s a question we hear many times from our clients at Glassman Wealth Services who want to maximize their retirement savings. To get a better understanding of whether you qualify to put retirement savings into an IRA and which option may be the better choice, let’s take a look at the differences and nuances between a traditional IRA and a Roth IRA:

Who Should Use A Traditional IRA?

The most compelling reason to contribute to a traditional IRA rather than a Roth IRA is that you expect to be in a lower tax bracket during retirement and want the tax deduction now. If you’re still working, you’ll benefit from the tax deduction while you’re in a higher tax bracket. Your retirement dollars will grow tax-deferred, and you’ll pay tax at a lower rate when you withdraw the funds during retirement.

Keep in mind that traditional IRAs are subject to required minimum distributions (RMDs) beginning the year you turn 70 ½, so you will have to pay tax on that earned income eventually.

Learn more about Required Minimum Distributions including when to take them and how to calculate them.

Are you planning to leave dollars to charity upon your passing? For many of our philanthropic clients, we recommend they name their favorite charities as the beneficiaries of their traditional IRA. Unlike your heirs, charities are not required to pay tax on the distributions, so they will receive the full balance upon your passing. Your estate also receives a deduction for the charitable contribution!

Who Should Use A Roth IRA?

The Roth IRA is a good choice for individuals who are okay not receiving a tax benefit now (likely while at a lower tax rate) with the plan that they will receive tax-free distributions during retirement.

Another benefit: Roth IRAs don’t have required minimum distributions (RMDs), so this will reduce taxable income during retirement. If you’re survived by your spouse, they can roll your Roth IRA into their Roth IRA without having to take an RMD in their lifetime.

Younger individuals that have longer time horizons are also great candidates for Roth IRAs. They are most likely in a lower tax bracket, and it’s anyone’s guess what tax rates will look like during their retirement in 30-40 years. Tax free withdrawals eliminate that concern!

Contribution Limits:

There are income limits to contributing to traditional and Roth IRAs. If you or a spouse participates in an employer-provided retirement plan, you may not be able to deduct all of a traditional IRA contribution. The Roth IRA does not have deductibility limits, but is subject to income limits. The chart below includes the phase-out of eligibility/deductibility for Modified Adjusted Gross Income (MAGI) at the low end of the range for 2014.

IRA MAGI limits 2

Contributions To Traditional IRAs And Roth IRAs:

Contributions into a traditional IRA are not allowed after age 70 ½, but there are no age restrictions on Roth IRAs. For those individuals with earned income after that age, it’s a great opportunity to continue putting money away for retirement.

Withdrawals From Traditional IRAs And Roth IRAs:

For a Roth IRA, you have the ability to withdraw contributions (the after-tax money you put in) from a Roth IRA account at any time. You can withdraw your earnings tax-free if you’ve had your Roth IRA for at least 5 years. However, withdrawing earnings before age 59 ½ will incur a 10% penalty.

You’ll have to pay taxes on both contributions and earnings withdrawn from a traditional IRA, and like the Roth IRA, you’ll have to pay an additional 10% penalty if you take that money before age 59 ½.

There are exceptions, so you should consider the Rules to Avoid a Penalty.

Who Should Consider Converting A Traditional IRA To A Roth IRA?

For families with sizeable estates, converting traditional IRA assets to Roth IRA accounts can be effective ways to reduce their taxable estates, reduce their future RMDs, and allow their heirs to receive tax-free distributions upon their passing. I plan to talk more about Roth IRA conversions in a future article.

Regardless of which type of IRA account you choose, the most important step is just saving for retirement. Start young and get in the routine of putting away money each year. Evaluate your goals, income levels, and tax rates on an annual basis, or speak to a financial advisor to determine the method that makes the most sense for you and your family.

If you would like to know more about which IRA option is best for you, please Contact Us.

Travis Russell, CFP®
PLEASE SEE IMPORTANT DISCLOSURE INFORMATION

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  1. […] If you’re earning less income than last year and have retirement savings accumulated, now may be a good time for a Roth conversion. […]