“Roth IRA or Traditional IRA…Which is Best?”
The two main types of Individual Retirement Accounts (IRA’s) that you can invest in are a traditional IRA or a Roth IRA. The main difference between the two accounts is how and when your money is taxed. With a Roth IRA your contributions are NOT tax deductible going in, but when you make withdrawals in the future, they are completely tax free. With a traditional IRA, you get a tax deduction for contributions that you make today, but your withdrawals are taxed in the future. So, people tend to make the decision about which is best for them by asking whether they plan on having a higher tax rate today or in retirement. While this is a valuable question to ask, there are many other factors to consider when making the decision between a traditional or Roth IRA.
Eligibility for either IRA type is important
With a traditional IRA you can make contributions regardless of your annual income, however the amount you are allowed to deduct for tax purposes does start phasing out at certain income levels. With a Roth IRA you can only contribute if your income is below a certain level. For most individuals, the income levels are a non-factor, but it is important to be aware of these before taking the leap. Just remember, you can ALWAYS contribute to a traditional IRA, but it might NOT ALWAYS be deductible.
Required Withdrawals
Another important point to be aware of is when each type of IRA requires you to start taking withdrawals in retirement. With a traditional IRA, an individual is required to begin taking their required minimum distribution (RMD) by April 1st, of the year after they reach 70 ½. With a Roth IRA, you are never required to withdraw funds, regardless of your age. For this reason, many investors find the flexibility of the Roth IRA to be beneficial. This can also provide estate planning benefits since the Roth IRA is more likely to maintain its value and be passed down to beneficiaries since there are no RMD rules.
Roth IRA and 401K Savings Provide Tax Diversification
Another point to make for individuals already contributing to a 401K plan through their employer is that the Roth IRA provides a tax diversification strategy for the investor. The tax treatment of a 401K and Traditional IRA is identical in the sense that you use “pre-tax” dollars to invest, but then pay taxes on withdrawals in retirement. By contributing to a Roth IRA and 401K plan simultaneously, you hedge your bets on your tax burden in retirement since you will have one account which has tax free withdrawals (the roth), and one account which is taxed (the 401K).
Each person has a unique set of circumstances that need to be evaluated before making a final decision, but for most individuals the Roth IRA provides great flexibility, attractive tax treatment, and estate planning privileges that the traditional IRA just doesn’t compete with. If you, or someone you know, has questions about their retirement plans and where they should be investing their money, then reach out to one of our financial advisors today for a free consultation!
June 14th, 2019