To Roth or not to Roth? That is the question…
When evaluating whether a Roth IRA would be a better option than a Traditional IRA, it pays to look at the differences and ask why one would be better than another. It all depends on your personal savings goals and tax planning. Let’s go over some basic provisions of each type of IRA.
Both IRAs permit a contribution up to $5,500 (2018 limit) plus a catch up of $1,000 if you are 50 or older. This is where the similarity ends.
A Traditional IRA may provide a tax-deductible contribution. You receive the tax benefit today and pay taxes in the future. This benefits an individual that needs to reduce his or her current taxable income and is willing to accept future tax rates in the expectation they will be lower. Keep in mind that both the deductible contribution and any investment earnings will be taxed at the time of the distribution, and early distributions before age 59-1/2 draw a 10 percent penalty. There are no income limits, and you aren’t required to take distributions until you’re 70-1/2.
A Roth IRA offers tax-free growth and tax-free withdrawals. You pay income tax up front on your contributions, which might be limited by your income, but you can withdraw those contributions at any time without penalty. Also on the plus side, you won’t have to take minimum distributions as long as you live – though that won’t be the case for your beneficiaries. As long as you’re 59-1/2 and own the account for five years, any withdrawal is tax- and penalty-free.
Of course, anytime you work with tax planning, nothing can be that simple. There are income restrictions on taking a tax deduction for a Traditional IRA contribution and in making a Roth IRA contribution. In addition, to get the benefit of the Roth IRA tax-free distribution, you need to hold it for at least five years and meet any of the following criteria: age 59 1⁄2 or older, death, disability, or first-time homebuyer.
Don’t forget to look into the saver’s credit if you file a joint return and your income is below $63,000, as head of household with income below $47,250 or as an individual with income below $31,500. You can get a tax credit for your contribution to either the Traditional or Roth IRA.
What’s the word on the street? Some feel with the new tax rates, now is the time to take advantage of a Roth IRA. The expectation is that tax rates will eventually rise. Those who are younger and in lower tax brackets are looking to take advantage of the tax-free earnings distribution at retirement. With many years to save and compounding of investment gains, this can be a significant savings. Then there’s the individual who has been saving for many years using the tax-deductible IRA and wants to diversify the taxable income in retirement by using the Roth IRA. This will allow distributions of both taxable and non- taxable amounts to control the taxes paid in retirement.
Even a high school student can take advantage of the Roth IRA savings. Sam has a part-time job while in school. He puts $42 per month in a Roth IRA because his mom told him to put part of his income into savings. Over five years, he saves a total of $2,520 from that part-time job. If Sam does nothing with the Roth IRA and we assume it is worth $10,000 when he reaches 59 1⁄2, Sam would need to say “Thanks mom for $7,480 of tax-free income!”
Whichever IRA you choose, you’re doing the right thing by saving for your future – and that’s a decision where you can’t go wrong.
If you would like to talk to one of our experienced professionals about which IRA might be right for you, call us at 937.324.6837.