Understanding Roth and Traditional IRAs

One of the most common questions we receive as financial planners is, “Which type of IRA is best for me: Roth or Traditional?” Both Roth and Traditional IRAs are excellent retirement savings tools, but each has its own advantages and disadvantages. Like Traditional IRAs, Roth IRAs allow individuals to invest in the market and avoid paying capital gains taxes on their investments. Both IRA types also have 401(k) counterparts, provided that your retirement plan allows for them.

The key difference lies in how taxes are applied. With a Roth IRA, you pay taxes on your contributions when you make them, while in a Traditional IRA, taxes are paid when you take distributions. Roth IRAs offer tax-free distributions, including investment earnings, when you reach retirement age. Additionally, Roth IRA contributions can be withdrawn at any time without penalty, provided certain conditions are met.

Choosing the Right IRA Based on Your Tax Bracket

When determining which IRA is best for you, the first consideration is your tax bracket. If you expect your taxes to be lower in retirement, a Traditional IRA may be the better option. Conversely, if you believe you’ll be in a higher tax bracket when retired, a Roth IRA may be more advantageous.

For 2019, the maximum contribution to a Roth IRA is $6,000, up from $5,500 in 2018. Individuals over age 50 can contribute an additional $1,000. Both Roth and Traditional IRAs have income thresholds, but they differ in how they affect your eligibility. Roth IRA thresholds refer to income limits for contributing, while Traditional IRA thresholds impact your ability to deduct contributions.

For example, in 2019, a married couple with a modified adjusted gross income (MAGI) of $190,000 cannot deduct their Traditional IRA contributions. They can still contribute, but without the tax deduction, or opt for Roth IRA contributions. In this case, it may make sense for the couple to contribute to their Roth IRA after both spouses have contributed $19,000 each to their respective 401(k)s ($25,000 if they are over 50).

If you need help deciding which IRA is the best choice for your situation, don’t hesitate to contact us for a consultation.

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