Roth IRA or Traditional IRA? It Depends.
If you are in the decades of your life where you are saving for retirement, you may ask whether you should be contributing to a traditional pre-tax IRA or 401(k), or to a Roth IRA or 401(k). While it seems like this should be an easy answer, it really depends.
I recently spoke with a client who is in medical school. He is earning a modest income now and while it is not easy to save, he understands the time value of money and the magic of compounding. Modest income puts him in a low tax bracket now, so the dollars he is saving into his Roth IRA are contributed after paying very little tax, will grow tax free and be withdrawn tax free as long as he follows all of the IRS rules for Roth IRAs. Once he becomes a physician, the IRS will not allow him to contribute to a Roth IRA because his income will be too high. He may or may not be offered a Roth 401(k) through a future employer and even if he did have the opportunity to contribute, he would pay far more tax on future contributed dollars than he will now. For this client, he is best off contributing to a Roth IRA.
I have a husband-and-wife client couple who are both in their early 50’s and are high income earning executives. They have maximized contributions to their traditional pre-tax 401(k)s, enjoying the tax deduction from their high income now. Once they retire, we will look for low tax bracket years of income for opportunities to convert. For them, now is not the time to Roth.
I have a newer client couple who recently retired. We began meeting early in the year to formulate a sound retirement income plan with a retirement date set for mid-year, at age 62. They have a couple of million dollars in traditional, pre-tax retirement accounts and under a hundred thousand dollars in Roth IRAs. He had been maximizing contributions to the Roth portion of his 401(k) to help this imbalance. To their surprise, I advised him to immediately switch course and maximize contributions to his pre-tax portion of his 401(k) for the remainder of his employment. Since the pre-tax contributions will lower his income, it would potentially help their plans to purchase health insurance on the exchange, since the insurance credits are income based. Later, when he no longer has earned income, we can look for opportunities to convert.
So which is better, a Roth IRA or a Traditional IRA? The answer is, it depends.
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This material was created for educational and informational purposes only and is not intended as ERISA, tax, legal or investment advice. If you are seeking investment advice specific to your needs, such advice services must be obtained on your own separate from this educational material.
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.
A Roth IRA offers tax deferral on any earnings in the account. Qualified withdrawals of earnings from the account are tax-free. Withdrawals of earnings prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Limitations and restrictions may apply.