When introduced in 1975, Individual Retirement Accounts (IRAs) were the first government-sponsored, tax-advantaged tool designed to help people save for retirement. More than 40 years later, IRAs remain one of the most popular retirement savings tools in America.
While many people contribute to employer-sponsored 401(k) plans, IRAs can also be beneficial — especially for those who don’t have access to an employer 401(k) or other retirement plan. You have until April 15, 2019, to make an IRA contribution for tax year 2018.
Horses of Different Colors
Should you choose a traditional IRA or a Roth IRA? It’s important to understand the differences between them to make the best choice. Or you can opt to split your contributions between the two IRA types. The maximum (presuming your earned income is no less than the amounts mentioned below) that can be contributed, in aggregate, is $5,500 for 2018 and $6,000 for 2019 — plus an additional $1,000 for those age 50 or older.
The original (or traditional) IRA can enable retirement savers to deduct annual contributions, thus lowering current taxable income. But withdrawals, which generally begin in retirement, are taxed at ordinary-income tax rates.
Some people, however, want to minimize their income tax liability later in life so they’ve more money to spend when retired. So, effective in 1998, the Roth IRA was introduced, allowing tax-free withdrawals of principal and earnings.
But there’s a tradeoff: No tax deduction is allowed for Roth IRA contributions.
As you weigh the traditional vs. Roth IRA decision, the first thing to determine is whether you qualify to contribute to a Roth IRA.
If you’re single (or head of a household) and your modified adjusted gross income (MAGI) is greater than $137,000 (or $203,000 if you’re married and file jointly), for 2019 you can’t contribute to a Roth IRA. If you’re single and your MAGI is between $122,000 and $137,000 (or $193,000 and $203,000 if you’re married and file jointly), you can make a reduced Roth IRA contribution.
The next thing to determine is whether you qualify for a traditional IRA deduction. If you or your spouse is covered by a retirement plan at work, your deduction may be limited or eliminated, depending on your MAGI. If neither you nor your spouse is covered by a retirement plan at work, your deduction is generally allowed in full.
Benefit Now or Later?
Assuming you’re eligible for both, the decision about which type of IRA is better essentially comes down to which has more value for you: a tax deduction now or the ability to withdraw money tax-free later when you retire.
If you’re in a lower tax bracket today than you might be in retirement, you may prefer to take advantage of the tax-free growth and income offered by a Roth IRA. On the other hand, if you’re in a higher tax bracket today than you might be in retirement, you may prefer to take advantage of the current tax deduction offered by a traditional IRA.
The withdrawal rules for traditional and Roth IRAs could also affect your decision. With a few exceptions, distributions from traditional IRAs before age 59½ are included in gross income and subject to a 10% early withdrawal penalty. However, contributions (but not earnings) made to Roth IRAs can be withdrawn penalty- and tax-free at any age.
Also, you must begin taking required minimum distributions (RMDs) from traditional IRAs, with certain exceptions, when you turn 70½. But there are no RMDs with Roth IRAs that you’ve created. (Different rules apply for inherited IRAs.)
Get Expert Advice
There are a lot of nuances involved in making the traditional vs. Roth IRA decision. Be sure to consult with your financial and tax advisors for guidance in your situation.