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Two Roads: Traditional IRA vs. Roth IRA

Updated: Dec 20, 2023




To reach your destination with certainty, it's important to know the ins and outs of your vehicle. Different retirement accounts exhibit unique performance traits, each ideally suited for specific financial circumstances. Choosing the right vehicle for your journey is the first step!

The primary distinctions between a Roth IRA and a traditional individual retirement account (IRA) revolve around tax treatment and timing. Traditional IRAs offer the potential for immediate tax deductions, whereas Roth IRAs are funded with post-tax income (money that has already incurred taxation).

In the future, when you withdraw funds from a traditional IRA, you will be liable for taxes on any portion that has not yet been subjected to taxation, including deductible contributions and investment earnings. Conversely, with a Roth IRA, you have the advantage of making tax-free withdrawals.

When comparing the advantages of a Roth IRA versus a traditional IRA, a common assumption is that your tax bracket in retirement will be lower. Although this scenario might indeed materialize, it remains highly unpredictable.

Rather than making assumptions about a potentially lower retirement income tax bracket, it is more straightforward to make a choice between paying taxes upfront or deferring them.

If you prefer settling your tax liability now, especially when your account balance is relatively modest, a Roth IRA provides the means to achieve that objective.


If you would rather postpone taxation until retirement, a traditional IRA allows you to defer taxes until you decide to withdraw funds after reaching the age of 59½. If you opt for this approach, the IRS will institute mandatory minimum distributions (RMDs), typically commencing in your early seventies (with varying ages based on specific circumstances).

Who qualifies?

If you or your spouse have earned income, you qualify for an IRA. However, to get tax advantages, you must meet additional government requirements. Income limits depend on your filing status, how much you'll earn this year, and whether you have an employer-sponsored plan like a 401(k).

Traditional IRA: Income Limits

If you file as a single or head of household in 2023 and have a retirement plan at work, you must have a modified adjusted gross income (modified AGI) lower than $73,000 to get the complete deduction for a traditional IRA.

2023 IRA deduction limits if covered by an employer's retirement plan:


Roth IRA: Income Limits

If you are married filing jointly or a qualified widow(er) and earn more than $228,000, you won't be able to contribute to a Roth IRA.

2023 contribution limits for Roth IRAs



Of course, there are other limitations to consider for individuals in other situations. For up-to-date information on IRA limits and requirements, check out the IRS site here.

What is a Backdoor Roth IRA?

If you are concerned high-earning and concerned about income limitations, backdoor Roth IRA's could be considered an option. The backdoor Roth IRA strategy involves contributing to a traditional IRA first and then converting to a Roth IRA. Things to remember when comparing Roth and traditional IRAs

Never too soon: Comparing the benefits of a Roth and Traditional IRA are important, especially if you are just starting out in your career. The sooner you begin, the longer you are able to benefit from the compounded tax-free growth of a Roth IRA.

Life Expectancy: As people continue working well into their later years, it becomes vital to account for your family's historical longevity. If extended lifespans are a common trait in your family, a Roth IRA could present a more favorable option for augmenting your retirement income, owing to its absence of withdrawal constraints.

Can I have traditional and Roth IRAs at the same time?

You have the wonderful opportunity to utilize both retirement savings vehicles, provided that your contributions adhere to the government's guidelines. This approach enables you to enjoy a blend of tax advantages both in the present and as you journey towards the future.

Advantages and disadvantages of traditional IRAs

Advantages

  • Potential tax deduction: A traditional IRA contribution may come with a tax benefit. You may be able to deduct your contributions on your taxes, based on your income, which would reduce your annual earnings and lower your tax liability.

  • Tax deferral: You don't have to pay income taxes until you start taking withdrawals in retirement.

Disadvantages

  • Beware - taxes ahead: While receiving tax benefits while you're still working is fun, you will have to pay the IRS their share later in life.

  • Required minimum distributions: If you're lucky enough to avoid tapping into your account by your seventies, the IRS will make sure you take out a certain amount every year for the rest of your life. These mandatory withdrawals are called RMDs. All pre-tax retirement accounts are subject to RMDs.

  • Early withdrawals come with penalties: If you take out money before the designated time, it will be added to your taxable income for the year, and you may have to pay an extra 10% penalty. However, in some cases, there are distribution exemptions.

Advantages and disadvantages of Roth IRAs

Advantages

  • Tax-free growth: Since you paid your taxes upfront, your earnings are not subject to any additional taxes.

  • No RMDs: You don't have to withdraw your money if you don't want to.

  • No penalties: There is no penalty on any contributions you withdraw.

Disadvantages

  • No immediate tax break: Since your Roth IRA contributions were made with after-tax money, you won't feel that tax-free bliss until much later in life (it's worth the wait).

  • No take backs: While having access to your funds may seem like a nice perk, anything you take out stays out. You can't add money to your account later to compensate for your withdrawals.

Parting Ponderings

When determining where to invest your retirement funds, it's essential to take into account factors such as your existing tax bracket, your envisioned retirement age, and your aspirations. It's worth noting that you have the option to contribute to both plans simultaneously.

Your trusted financial advisor is your guiding light in choosing the retirement plan that aligns perfectly with your unique needs. They are also your go-to source for the most current information regarding government regulations and limits for tax-advantaged accounts.





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