Roth or Traditional: Which IRA Should You Choose?

Thinking about contributing to an individual retirement account, or IRA, this year? That could be a good move. An IRA allows you to save for retirement on a tax-advantaged basis, which could help you grow your savings at a faster rate.

Depending on your situation, you have several IRA options to choose from. Two of the most popular are the traditional IRA and the Roth IRA. Each has its own unique features and benefits, so you should consider your goals and needs before making a commitment to one.

Not sure which one is right for you? Ask yourself the questions below to get a better feel for which IRA option you should use.

Do you expect your tax rate to be higher in retirement?

One of the biggest differences between the traditional IRA and the Roth is how they provide their tax benefits. Generally speaking, a traditional IRA gives you a tax break today. The Roth IRA gives you a tax break in retirement.

With a traditional IRA, you get a tax deduction in the current year for your contribution, assuming you meet income limitations. If you’re a single person or head of household, you will get some form of contribution as long as your income is less than $71,000. For married couples who file jointly, that number is $118,000.1

In a traditional IRA, your investments grow tax-deferred. That means you don’t owe any taxes on your earnings as long as the money stays in the IRA. When you take a withdrawal, you will pay income taxes on the full withdrawal amount. That means the income you take from your traditional IRA could increase your tax obligation in retirement.

With a Roth IRA, there is no current year deduction. However, much like a Traditional IRA, you don’t pay taxes on your growth and earnings while your money stays in the account. When you take a withdrawal, however, the income is tax-free, assuming you are age 59 ½ or older. While you don’t get a tax benefit today from the Roth IRA, you can use it to create a tax-free income stream in retirement.

If you believe your tax rate will be higher in retirement, a Roth IRA could offer the most tax advantages. However, if you believe your tax rate will be lower in retirement, you may be better served by going with a traditional IRA.

Is there a chance you may take a withdrawal before age 59 ½?

In both IRAs, there are potential penalties for withdrawals before age 59 ½. However, the extent of those penalties differs between the traditional and the Roth. In a Traditional IRA, an early withdrawal is always taxable. You also may have to a pay a 10 percent penalty on the full withdrawal amount, unless you meet exception criteria.

In a Roth IRA, only your earnings are taxed when you take an early withdrawal. Similarly, you only pay the 10 percent penalty on your earnings. Your contributions can always be withdrawn tax-free and penalty-free. If you think you may take an early withdrawal, a Roth IRA could be the better option.

Do you want to avoid required minimum distributions?

The traditional IRA differs significantly from the Roth IRA after you reach age 70 ½. The traditional IRA has something called required minimum distributions, also known as RMDs. A RMD is a required withdrawal you must take from your traditional IRA, starting at age 70 ½ and continuing every year thereafter.

Your RMD amount is based on the balance of your IRA, your age and prevailing interest rates. Generally, you can expect the withdrawal amount to increase as you get older.

If you don’t like the idea of being forced to withdraw your own money, you may want to consider the Roth IRA. The Roth IRA doesn’t have RMDs. If you don’t need the money, you can keep it in the Roth, allowing it to accumulate for later in life or even as an asset to pass to your heirs.

1https://www.irs.gov/taxtopics/tc557.html

This information is designed to provide a general overview with regard to the subject matter covered and is not state specific. The authors, publisher and host are not providing legal, accounting or specific advice for your situation. By providing your information, you give consent to be contacted about the possible sale of an insurance or annuity product. This information has been provided by a Licensed Insurance Professional and does not necessarily represent the views of the presenting insurance professional. The statements and opinions expressed are those of the author and are subject to change at any time. All information is believed to be from reliable sources; however, presenting insurance professional makes no representation as to its completeness or accuracy. This material has been prepared for informational and educational purposes only. It is not intended to provide, and should not be relied upon for, accounting, legal, tax or investment advice.
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