Does the absence of a traditional or ROTH IRA mean no future IRA contributions? Let’s not give up so fast!Read More
By Frederick “Rick” Fisher, MS, CFP®
Over the years, we have had many clients ask, “Which should I invest in, a Roth IRA or traditional IRA?” They both are excellent retirement vehicles and generally can be invested in almost any asset. To illustrate the differences and determine which one is more appropriate, we will take the case of hypothetical clients, Jim & Sally Jones, and Roger Stevens.
Jim and Sally are a young couple starting out. They want to get an early start on retirement savings. Neither of their employers offer a retirement plan, so both are eligible for the tax deduction from a traditional IRA.
In order to determine which IRA is better for them, we needed to know their income and tax bracket. Since they are just starting out, their salaries are relatively low, and taxes are of secondary concern. In their case, a Roth IRA may be the better way to go, even though a Roth IRA contribution is not tax-deductible, while a traditional IRA is tax-deductible. The major benefit of a Roth IRA, however, is that under current law you are not taxed on distributions in retirement. Therefore, when they retire in 30 years, they will be able to start drawing on this account without an effect on their income tax. Assuming that income taxes will increase over time and that their income will be higher at retirement, this may be a significant benefit.
While the traditional IRA and Roth IRA both grow tax deferred, the main difference between the two is that you get the tax benefit upon contribution for the traditional IRA, and upon distribution for the Roth IRA.
Also, the contribution limits are the same. For 2019, the max you can contribute is $6,000 for those under 50 years old and $7,000 if you are 50 or over. There are income limits on Roth IRA contributions. For single filers the income limit is $137k Modified Adjusted Gross Income (MAGI), and for joint filers that increases to $203k.
For the Jones, this was not a concern. For Roger Stevens, it was.
Roger is 42 and investing in a new business that expects to make him between $120k and $150k this year. He likes the idea of tax-free income, because he has significant money in a 401(k), which like traditional IRAs, will be taxed upon distribution. He would like to have some flexibility regarding the tax treatment of retirement income.
We advised him to wait to determine his taxable income for this year and see if he qualifies for the Roth IRA. If not, he could still add to his traditional IRA, along with other plan options that are available. Since both plans allow prior year contributions up to April 15 of the following year, that buys Roger some time to make a decision.
Another advantage of the Roth IRA that both the Jones and Roger liked was that they are not forced to take money from the Roth IRA at 70½. They are forced, however, to take from a traditional IRA and most other retirement plans.
With this information, the Jones started Roth IRAs for themselves. Roger decided to wait to see where his MAGI for 2019 will be. If possible, he would then open a Roth IRA. If not, he would add to his existing traditional IRA.
Should you want advice on how to best allocate your tax advantaged retirement dollars, call our office for a complementary review.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change. Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax. This is a hypothetical situation based on real life examples. Names and circumstances have been changed. To determine which investments or strategies may be appropriate for you, consult your financial advisor prior to investing.
Frederick Fisher is a Registered Representative with, and Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Ostrofe Financial Consultants, Inc., a Registered Investment Advisor and separate entity from LPL Financial.
For questions or suggestions, contact Frederick at (530) 273-4425, or firstname.lastname@example.org, or visit ostrofefinancial.com. Branch address: 420 Sierra College Drive, Suite 200, Grass Valley.