Traditional vs. Roth IRAs

Ben Waller |

 

            Retirement may seem like a distant issue, but it is never too early to start planning for the type of retirement you envision for yourself. When it comes to saving money for retirement, there are many different paths you can follow. Individual retirement accounts, or IRAs, are a retirement account where the individual is responsible, instead of the employer, as in the case of a 401k and other qualified retirement plans. There are two types of IRAs: Traditional IRAs and Roth IRAs. While they are similar in many regards (they both allow you to make annual contributions that can appreciate via tax deferred growth), they also differ in crucial ways. It is important to understand the differences to make the best decision in order to maximize the value of your retirement savings.

            A quick way to see what plan is best for you depends on your answer to this question: will your tax rate be higher or lower come retirement? If lower, then a Traditional IRA may be the best option, while if higher, a Roth IRA may be more suitable. If you are unable to answer this question, as many are, then there are other nuances within the plans to consider.

            In basic terms, Traditional IRA contributions are less expensive in the short run. This plan has an immediate tax subsidy for those whose income level qualifies them for a tax deduction. The cost of a tax deduction today comes in the form of taxes later in life upon commencing distributions from the account. There are no income restrictions to open a Traditional IRA, but there is an age limit. To contribute to a traditional IRA account, you must be under the age of 70½. Once you reach that age, you must start taking out a percentage of the assets annually due to required minimum distribution (RMD) rules.

One who fails to meet the required minimum distribution target is subject to a 50% penalty of any shortfall. If you believe your taxable income will be lower by the time you begin receiving RMDs, then you may benefit from a Traditional IRA. The tax rate applied on distributions may be lower than the rate applicable when the original contributions were made.

            On the contrary, Roth IRAs are more about saving money later in life. While there are no immediate tax breaks for Roth IRAs, the growth within the account and withdraws from the account are tax-free. While you contribute to a Roth using post-tax dollars, you aren’t taxed later in life upon making withdrawals. Also, there are no age restrictions, nor RMDs, so you do not have to start taking out money until you see fit. Thus, a parent can pass the full value of a Roth IRA account to future generations. Once inherited, money must be taken out of the account annually by the beneficiary. There is an income restriction on Roth IRA contributions, as account owners who are single must make under $122,000, or if married $193,000, to qualify to make the maximum contribution. A Roth IRA may be the best route if you believe you will be earning a higher income in the future compared to when the account was opened.

           Both account types have positive attributes, but each investor’s unique circumstances will determine the better fit. This summary is just a start to understanding the two options, so when ready to make a decision, a deeper look into each plan will prove beneficial. We recommend contacting your advisor or tax professional for additional information before making a choice.   

 

           Below is a table for an easy comparison of the features of the accounts:

 

Name

Roth

Traditional

Age Limitations

Can contribute/ withdraw at any age

At 70½, can no longer contribute and must start to withdraw

Income Restrictions

$122,000 if single, $193,000 if married

Anyone can contribute, but tax deductibility may be affected

Annual Contribution Limit

$6,000; $7,000 if 50 or older for 2019

$6,000; $7,000 if 50 or older for 2019

Tax Treatment

No tax break for contributions; tax-free earnings and withdrawals in retirement

Tax deduction in contribution year; ordinary income taxes owed on withdrawals

Required Minimum Distributions?

Not during your lifetime

After 70½, annual withdrawal requirements

Contribution Deadline

April 15

April 15

Early-Withdrawal Rules

Can withdraw contributions at any time, after 5 years up to $10,000 in earnings can be taken out penalty free

Before 59½, withdraws come with a 10% penalty, plus withdraw is taxed as ordinary income

 

        Below is a table showing those who qualify for a tax deductible contribution for their Traditional IRA .

 

Filing status

Full deduction if modified AGI is…

Partial deduction if modified AGI is ...

No deduction if modified AGI is ...

Married filing jointly and you are covered by a retirement plan at work

2018: $101,000 or less

2019: $103,000 or less

2018: More than $101,000 but less than $121,000

2019: More than $103,000 but less than $123,000

2018: $121,000 or more

2019: $123,000 or more

Married filing jointly and your spouse is covered by a retirement plan at work

2018: $189,000 or less

2019: $193,000 or less

2018: More than $189,000 but less than $199,000

2019: More than $193,000 but less than $203,000

2018: $199,000 or more

2019: $203,000 or more

Single or head of household and you are covered by a retirement plan at work

2018: $63,000 or less

2019: $64,000 or less

2018: More than $63,000 but less than $73,000

2019: More than $64,000 but less than $74,000

2018: $73,000 or more

2019: $74,000 or more

Married filing separately and you or your spouse is covered by a retirement plan at work

2018: Not available

2019: Not available

2018: Less than $10,000

2019: Less than $10,000

2018: $10,000 or more

2019: $10,000 or more