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Traditional IRA vs. Roth IRA: What You Need to Know

Traditional IRA vs. Roth IRA: What do I need to know to select the right one to match my family’s goals? People often ask me this question after they learn that I am a CERTIFIED FINANCIAL PLANNERTM professional. Let’s walk through the Traditional vs. Roth IRA conversation.

How are Traditional and Roth IRAs similar?

  • Both are tax-advantaged building blocks, along with your workplace retirement savings plans, created to build the retirement income you need and deserve after your working career ends.
  • They both have maximum yearly contributions of $6,000 ($7,000 for those age 50 or older).
  • Each has “fine print” related to contributions and restrictions. Check out Internal Revenue Service Publication 590 A (link) to learn more.

Tell me the advantages of Traditional IRAs and Roth IRAs?

  • Traditional IRA — Save taxes now! Traditional IRA contributions may be tax-deductible, and the earnings are not taxed as the money grows. What this means for you is that you may owe less or get a bigger income tax refund from the Internal Revenue Service at tax time in the year you make a deductible contribution.
  • Roth — Save taxes in retirement! Qualified withdrawals from a Roth after age 59 ½ are income tax free. What this means to you is that you keep all the withdrawals for yourself instead of paying part in taxes to the Internal Revenue Service. Fewer taxes mean more to spend. Plus, your beneficiaries inherit the Roth income tax-free.

Tell me the disadvantages of Traditional IRAs and Roth IRAs?

  • Traditional IRAs are only tax-deferred, which means you delay paying tax but do not avoid paying taxes forever. When you withdraw from an IRA, even after age 59 ½, you will pay income taxes on deductible contributions and earnings. Plus, you must begin withdrawing from your IRA at age 72 based on required minimum distribution rules. Ultimately, distributions to your beneficiaries will be taxable income.
  • Roth IRAs do not give you a tax break up front. Roth contributions are not tax-deductible, which means you do not pay less in taxes in the tax year in which you contribute to a Roth.
  • Again, both IRA and Roth have “fine print” related to distributions, so check out Internal Revenue Service Publication 590 B.

Okay, I see the similarities and differences, but what should I do?

  • Contributions to a Traditional IRA win if you project you will be in a lower income tax bracket in retirement compared with the tax bracket you’re in today.
  • Contributions to a Roth win if you project you will be in a higher tax bracket in retirement compared with your tax bracket today.

In real life, the decision can be far more complicated, which is why it is important to make this decision in the context of an overall financial plan. Here are but a few of the complications:

  • It is difficult to project if you will be in a higher or lower bracket in retirement without doing the numbers in a financial plan, including projected salary/contribution growth rates and projected long-term investment returns and inflation to crunch the math. Plus, you need to add in Social Security projections and possible higher Medicare premiums based on income.
  • Many people also ask what if income tax rates are increased to a higher level in the future? In that case, you might pay more in taxes even at the same income level. “What if” projections may be a factor when thinking about what your future taxes might be.
  • A frequent question is should I convert my traditional IRA to a Roth IRA? Again, this requires advanced knowledge and training to compute.

How do I end the conversation on Traditional vs. Roth IRA? I see three key steps.

  • Do not take any action based on high level generic educational points from me or anyone else.
  • It all starts with “Let’s make a plan.”
  • It’s complicated, so you need to work with someone over time who can craft your plan and update your plan to reflect your progress toward multiple goals, including saving for retirement based on your specific situation.

If you need someone to help you build financial security, one resource to use is the Find a CFP® Professional search tool to help you find a CERTIFIED FINANCIAL PLANNERTM professional.

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