Traditional vs. Roth IRA
Navigating Retirement Savings: Exploring the Pros and Cons of Traditional and Roth IRAs
When it comes to retirement planning, the two most popular types of Individual Retirement Accounts (IRAs) are the Traditional IRA and the Roth IRA. While both can be great vehicles for retirement savings, each IRA has its own unique attributes that can make it a better fit for certain individuals. In this article, we will discuss the differences between a Traditional IRA and a Roth IRA, and the pros and cons of each.
A traditional IRA is a retirement savings account that allows individuals to contribute pretax dollars into the account. This means that the money you contribute to your traditional IRA is tax-deductible, which can help lower your taxable income in the year you make the contribution. The earnings in the account are also tax-deferred, which means you won’t pay taxes on them until you withdraw the money in retirement.
- Tax benefits: The biggest advantage of a traditional IRA is the tax benefits it provides. By contributing pretax dollars, you can reduce your taxable income for the year you make the contribution, which can lower your overall tax bill.
- Lower tax bracket: If you expect to be in a lower tax bracket when you retire, a traditional IRA may be a good option for you. Since you’ll pay taxes on your withdrawals in retirement, if you’re in a lower tax bracket, you’ll pay less in taxes overall.
- More flexible withdrawals: With a traditional IRA, you can start making withdrawals penalty-free at age 59 1/2. However, you must start taking required minimum distributions (RMDs) at age 72.
- Taxes in retirement: Since you didn’t pay taxes on the contributions you made to your traditional IRA, you’ll have to pay taxes on your withdrawals in retirement. This means that your retirement income could be lower than you expected.
- RMDs: With a traditional IRA, you must start taking RMDs at age 72, which means you may be forced to withdraw money from your account even if you don’t need it. This can increase your taxable income and potentially push you into a higher tax bracket.
A Roth IRA is a retirement savings account that allows individuals to contribute after-tax dollars into the account. This means that you won’t get a tax deduction for your contributions, but the earnings in the account grow tax-free. You also won’t have to pay taxes on your withdrawals in retirement, as long as you follow certain rules.
- Tax-free withdrawals: The biggest advantage of a Roth IRA is that your withdrawals in retirement are tax-free, if you’ve had the account for at least five years and you’re at least 59 1/2 years old.
- No RMDs: With a Roth IRA, you’re not required to take RMDs at any age. This means you can leave the money in the account for as long as you like, allowing it to continue to grow tax-free.
- Flexibility: Since you’ve already paid taxes on the money you contribute to a Roth IRA, you can withdraw your contributions penalty-free at any time. This makes a Roth IRA a good option for people who want to save for retirement but also need flexibility in case of an emergency.
- No tax deduction: Unlike a traditional IRA, you won’t get a tax deduction for your contributions to a Roth IRA. This means that your taxable income won’t be lowered when you contribute.
- Income limits: There are income limits for contributing to a Roth IRA. If you make too much money, you won’t be eligible to contribute to a Roth IRA at all.
- No immediate tax benefits: Since you’re not getting a tax deduction for your contributions, you won’t see any immediate tax benefits from contributing to a Roth IRA.
In addition to contribution and distribution rules, there are limits on how much can be contributed each year to either IRA. In fact, these limits apply to any combination of IRAs; that is, workers cannot put more than $6,500 per year into their Roth and traditional IRAs combined. So, if a worker contributed $3,500 in a given year into a traditional IRA, contributions to a Roth IRA would be limited to $3,000 in that same year.
Both traditional and Roth IRAs can play a part in your retirement plans. And once you’ve figured out which will work better for you, only one task remains: open an account.
Opportunities to do a conversion from a traditional IRA to a Roth IRA should be evaluated each year. While this conversion would create taxable income, you are setting yourself up to generate tax free income in the Roth IRA for the future. Consideration should be given to possible lower income years utilizing the lower income tax brackets. Normally the years from retirement until you start taking required minimum distributions are prime years for this conversion. Projecting taxable income and utilizing tax bracket efficiency will determine if this is the right strategy for your personal situation.
Overall, which IRA is best for you depends on your individual financial situation, retirement plans and risk tolerance. It’s important to speak with an advisor to discuss options and determine which type of IRA is best for you. Contact an Adams Brown wealth management advisor to discuss which option is best for you.