Financial Fundamentals – Traditional IRA vs. Roth IRASubmitted by Affiance Financial on September 12th, 2019
A question that we are often asked, on a pretty regular basis, is if someone should contribute to a Traditional IRA or Roth IRA. Like most things in our industry, we have a phrase for something like this, “it depends.”
Both Traditional IRA and Roth IRAs are retirement savings accounts, however there are key differences when it comes to how each are taxed.
There are a number of eligibility tests that take place as to whether you can even make a traditional IRA contribution, but for the sake of this post, let’s say you can. When you are putting money into a traditional IRA, you are putting it in as a pre-tax contribution. This reduces your taxable income, thus effectively lowering your taxes. A reason for doing this would be that maybe you need to bring your income down to stay within a particular tax bracket.
When it comes to distributions, they are treated as 100% taxable income and you are subject to taxes at whatever the rate is once you take money out. If you happen to take out a distribution prior to age 59.5, you would be subject to an additional 10% penalty, as well income taxes. There is also a required minimum distribution once you reach age 70.5. This isn’t necessarily a spending requirement, but rather a tax requirement. Essentially once you reach 70.5, Uncle Sam wants his cut since the money has been tax-deferred for a long period of time.
For 2019, the maximum contribution that can be made to a traditional IRA is $6,000, and if you are over 50 years old, you are eligible to make an additional catch-up contribution of $1,000, bringing the total to $7,000.
On the flip-side, when you contribute to a Roth IRA, you are using after-tax dollars so you do not receive a reduction of income on your taxes, and the account grows tax-free, as well as is distributed tax-free. Being able to have the money grow tax-free, especially for a long period of time, could add up. There are also no required minimum distributions, and can continue to be added to even after age 70.5.
Unfortunately, not everyone can make a Roth IRA contribution. For 2019, you are able to make a full Roth IRA contribution if your modified adjusted gross income is below $193,000 for married filing jointly and $122,000 for single filers. The amount completely phases out once you reached $203,000 married filing jointly, and $137,000 for single filers.
Here is where the rubber meets the road. You may be asking yourself, “this is all great information, but should I make a traditional IRA or Roth IRA contribution?” The answer is if you are expecting your taxes in the future to be higher than they are currently, then making a Roth IRA contribution most likely makes the most sense, since you are taking advantage of the potential difference in tax rates. Given the current tax system, we are currently in a low tax environment, so taking advantage of making Roth IRA contributions now could potentially turn out to be very powerful in the future. On the other hand, looking at it from the traditional IRA point of view, it may make more sense to contribute to a traditional IRA to try and bring income lower, as long as cash flow permits.
Ultimately, it comes down to your personal financial goals and it all starts with a conversation. Your Affiance Financial Advisor remains available to help determine which strategy makes the most sense for your goals. Reach out to your Advisor to discuss your personal situation today.
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