Money & Career
Roth vs Traditional IRAs: Which Is Right for Your Retirement?
4/1/2019 1:00:00 PM

Roth vs IRA

Both traditional and Roth IRAs can be effective retirement savings tools, but eligibility limitations mean one or both may not be right for you. Here’s a guide to help you choose.

What’s the difference between a traditional and Roth IRA?

A traditional IRA is an individual retirement account that allows you to make contributions on a pre-tax basis (if your income is below a certain level) and pay no taxes until you withdraw the money. This makes traditional IRAs an attractive option for investors who expect to be in a lower tax bracket during retirement than they are now.

On the other hand, Roth IRA contributions are made with after-tax dollars. The benefit of a Roth IRA is that you can withdraw your contributions and earnings tax-free after age 59½, if you’ve had the account for at least five years, or you meet certain other conditions. In addition, your after-tax contributions to the Roth account can be withdrawn at any time, tax and penalty-free (however, if you make an early withdrawal of any earnings you will have to pay taxes and penalties on them).

This makes a Roth an attractive option for investors who expect to be in a higher tax bracket during retirement than they are now. A Roth IRA can also offer some spending flexibility in retirement, as money can be withdrawn without increasing your tax bill and you won’t have to take annual required minimum distributions (RMDs) after you turn 70½.

How much can I contribute?

The maximum amount you can contribute to a traditional or Roth IRA in 2019 is $6,000, up from $5,500 in 2018. The catch-up contribution for those ages 50 or older remains $1,000, bringing the total contribution for those 50 and older to $7,000. However, there are some rules that affect IRA contributions and deductibility. Here’s an overview:

Traditional IRA

There is no income limit for contributing to a traditional IRA, and the contribution is fully deductible if neither you nor your spouse was covered by a retirement plan at work during the tax year. However, if either of you was covered by a workplace retirement plan, deductibility phases out depending on your filing status and income:

Roth IRA

Roth IRA contributions are made with after-tax dollars. You can contribute to a Roth IRA only if your income meets certain limits and depending on filing status. (Consult your tax preparer or financial planner for parameters.)

So, if you do qualify for a traditional IRA (with the ability to deduct contributions) and a Roth IRA, how do you choose between them? Here are thoughts and guidelines to help you make a decision:

– If you think your tax bracket will be higher when you retire than it is today, you may consider a Roth IRA—especially if you’re a younger worker who has yet to reach your peak earning years.

–If you think your tax bracket will be lower when you retire, you may be better off taking the up-front deduction of a traditional IRA. If you think your tax bracket will be the same when you retire, it’s almost a wash for income tax purposes. However, you aren’t subject to required minimum distributions (RMDs) with a Roth, and if you leave it behind when you die, your heirs can stretch out their own tax-free withdrawals. A Roth IRA can also be a flexible source of retirement funding: You can withdraw a large sum, if you have a large one-time expense or other needs in retirement, without increasing your tax bill. Allocating a portion of your retirement savings to a Roth can increase the flexibility you have to manage taxes in retirement. 

Another advantage of a Roth IRA is that contributions may be withdrawn any time for any purpose without tax or penalty. However, just because you can do this doesn’t mean you should. The opportunity costs are high—taking money out of your Roth IRA means you may miss out on compounding interest. When you can put in only $6,000 for 2019, plus an additional $1,000 "catch-up” contribution if you’re age 50 or older, taking out previous contributions may be hard—or even impossible—to make up.

Finally, we can’t know with certainty future tax rates. Contributing part of your retirement savings dollars to a Roth IRA after paying taxes can add tax diversification of your retirement savings in the event Congress increases tax rates in the future or when you retire.

The bottom line

A Roth IRA can be a great long-term savings tool, so try to take advantage of these rules if you can. Just remember that tax laws are subject to change, so check out the IRS’s Latest News page regularly for updates. Also, be sure to talk with your accountant or other professional tax advisor about whether a Roth IRA makes sense for you.

Test your Financial Literacy

April is Financial Literacy month, which allows government, private sector, and non-profit organizations to highlight their efforts in personal finance education. Financial literacy should be a year-round discussion, but the month of April is a great place to start. For many, this is the time of year when we look back at last year’s finances, with April 15 being the tax filing deadline. The information you have from last year’s finances can be a good tool to set up a budget for this year and beyond. There are four steps to take this month on a personal level, and we hope you continue your efforts well after financial literacy month has ended:

Create and Follow a Budget

A budget need not be complex or technical, just accurate and up-to-date. Even keeping a simple budget on a sheet of paper can go a long way in improving your financial situation. There are websites and internet tools that can keep track of everything for you, including alerting you when bills are due.

Don’t Be Afraid to Talk about Money

If your personal finances are combined (or will be soon) with a significant other, have the money talk. According to a New York Times article, "Research shows that money is the number one reason couples fight and a main reason marriages split up.” Like many other things in relationships, communication is essential. Take some time out of your schedule to sit down and work on your finances together. Have a good idea of your budget, as well as spending and saving priorities to help avoid issues going forward.

Pay Down Debt

Paying down debt has countless benefits, including relieving stress and reducing finance charges. "Debt or money is such a pervasive and difficult kind of stress because it’s so interconnected with other areas of our lives,” said Kelly McGonigal, Ph.D., a psychologist and researcher at Stanford University. Regardless of what caused the debt, paying it back is not always easy. Be sure you know all your options, and don’t get discouraged. It may seem like a long journey, but it will be well worth it in the end.

Start Teaching Money Management Early 

If you have children, start talking to them about money early. It’s not necessary for your five-year-old to understand the difference between hard and soft inquiries on a credit report. Yet, explaining to a young child why they need to save money if they want to buy new toys is a good place to start. Try starting with a money counting game. As children grow, introducing them to the entire spectrum of personal finances can help them have a better financial future. Saving and borrowing habits can be established long before they become adults, so teach good habits early and often.

Understanding your personal finances is a year-round task and it should not be limited to the month of April. In fact, financial education is a lifelong project. But the principles are the same. The goal? Spend less than you make, decrease debt, and increase your net worth. Sounds simple, but often it’s not. If you have the knowledge, you have the power to move in the right direction.

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