One question we frequently get from clients who are new to investing and retirement saving is, “Should I be saving into a Roth IRA or a Traditional IRA?”. When we get this question, we always respond with a follow-up question back to client that sounds somewhat like, “What are you trying to accomplish from a retirement planning perspective?”. The reason that we ask this, is because the main distinction between the Roth IRA and the Traditional IRA is the way contributions and withdrawals are taxed. Both Roth IRA’s and Traditional IRA’s offer tax advantage growth.
How Are They Taxed Differently?
With traditional IRA’s you receive a tax deduction against your adjusted gross income (AGI) when you put the money in. However, this deduction is only available if your modified adjusted gross income (MAGI) is below $64,000 for single tax filers and $123,000 for joint tax filers for 2019. If your income is over this amount, you are still able to make the contribution, it just cannot be deducted. Then, down the road when you have reached 59.5 years old, the age at which the IRS says you can now begin taking money from your IRA’s without penalty, you pay ordinary income tax on the withdrawals taken from the account.
When it comes to Roth IRA’s, unlike the traditional IRA you do not receive the tax deduction on contributions made into the account. However, because the contributions are taxed on the way in, withdrawals are taken from the account tax free when you reach 59.5 and can access the money without penalty. One added benefit to the Roth IRA that should be mentioned, is that contributions made into the account can be take out tax free and penalty free at any time. The downside with the Roth IRA is that if your MAGI is over $123,000 for single tax filers and $193,00 for joint tax filers for 2019, the IRS does not allow you to contribute to a Roth IRA.
Now that we have established and understand the tax differences amongst the two accounts, how do we choose which is best? At this point, we come back to our original question, “What are you trying to accomplish from a retirement planning perspective?”, and then follow up with a second question, “Do you expect your income to greatly increase in the coming years?”.
When a Traditional IRA Makes Sense
Starting with our first question, if our client’s main objective is to decrease their tax burden, then it probably makes the most sense for them to contribute to the Traditional IRA and receive the tax deduction. This especially would ring true, if the answer to our second questions was, “no”. The reason being, that if income is going to remain generally level, without any huge increases, when they start taking withdrawals in retirement this will most likely not create an issue adding to their tax liability in retirement.
When a Roth IRA Makes Sense
If the main objective of a client is to create maximum income in retirement and they believe that their income is going to increase soon, then the Roth IRA is the best option for them. A Roth IRA will allow this client to put money away for retirement, until they are phased out by the contribution limits and can no longer contribute, that can later be taken out tax free. This helps them to accomplish their goal of creating maximum income in retirement.
It is most likely, that in some way the IRS guidelines will affect your decision on whether you choose the Roth IRA or the Traditional IRA. In the end, it is important to remember that there is no wrong decision, the only wrong decision is taking no action. Saving and investing for retirement is critical and something that you will undoubtable thank your future self for. If you haven’t started, start now!
By: Myles Zueger, Senior Relationship Manager
The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Myles Zueger and not necessarily those of Raymond James. Contributions to a traditional IRA may be tax-deductible depending on the taxpayer’s income, tax-filing status, and other factors. Withdrawal of pre-tax contributions and/or earnings will be subject to ordinary income tax and, if taken prior to age 59 1/2, may be subject to a 10% federal tax penalty. Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Earnings withdrawn prior to 59 1/2 would be subject to income taxes, unless it meets specific conditions. Investing involves risk and you may incur a profit or loss regardless of strategy selected.