Do you hear the term Roth often and aren’t quite sure what it means?
Do you already know what it means but aren’t sure what is better for your situation?
I’ll explain the difference between a Traditional IRA compared to a Roth IRA and why you should consider each depending on your situation.
Comparison
First, you should know the main difference between Traditional IRAs and Roth IRAs is when you pay taxes. With Traditional you pay later, with Roth you pay now.
- Traditional
- You get a tax break the year you contribute. Your contributions lower your taxable income for the year.
- 2024 contribution limit is $7,000, if you are 50 or older it’s $8,000.
- Anyone with earned income can contribute, but whether you can deduct depends on if you have an employer plan available to you. If you’re married and your spouse has a retirement plan available the rules differ as well.
- If you are single with no workplace retirement plan, you can get the full deduction. Same for married with no workplace retirement plans for either of you.
- If you have a work retirement plan available:
- Single: full deduction up until MAGI (modified adjusted gross income) of $77,000. Partial deduction if less than $87,000.
- Married Filing Jointly: full deduction up until MAGI (modified adjusted gross income) of $123,000. Partial deduction if less than $143,000.
- Your money grows tax free.
- You pay taxes on your distributions.
- Early withdrawals will cost you a 10% penalty.
- Required Minimum Distributions: begin at age 73 for account owners born between 1951 and 1959; begin at age 75 for those born in 1960 or after. Beneficiaries are also subject to RMD rules.
- You can potentially withdraw up to $10,000 penalty-free to cover first-time home buyer expenses. Qualified education and hardship withdrawals are also available.
- Roth
- You don’t get a tax break the year you contribute.
- 2024 contribution limit is $7,000, if you are 50 or older it’s $8,000.
- Single tax filers with MAGIs (modified adjusted gross income) of less than $146,000 can contribute. At $146,000 begins to phase out and you are not eligible after $161,000.
- Married filing jointly people can contribute until MAGI of $240,000 and are ineligible after $230,000.
- Your money grows tax free.
- You do not pay taxes on your distributions.
- Early withdrawals will cost you a 10% penalty only if you withdraw more than you have contributed. Since you do not get a tax break when you contribute, your contributions can be withdrawn without penalty at any point.
- Required Minimum Distributions: none; beneficiaries are subject to RMD rules.
- After five years, up to $10,000 of earnings can be withdrawn penalty-free to cover first-time home buyer expenses. Qualified education and hardship withdrawals may be available without penalty before the age limit and five-year waiting period.
Theory Behind Selecting
Most experts tend to say that Roth is better in general, especially if you are younger and have more time to let it grow. Also, if you expect to be in a higher income tax bracket after you retire.
Mathematically, if you are in the same tax bracket when you contribute as when you withdraw, both accounts will be equal.
What I Do and Why
I have always contributed to the Traditional version of all of my accounts, including a Traditional IRA.
My reasons are:
- I get a tax deduction now.
- Contributions lower my AGI, which lowers my student loan payments (my biggest reason).
- In retirement:
- My withdrawals will be less than my current income, so my taxes will likely be less.
- My withdrawals will be controlled to what I want to have as income that year, so I can control what I get taxed on.
- My income will be from:
- investments held in retirement accounts.
- investments held in my brokerage account, which will generate capital gains taxes when sold and thus are a lot more favorable when they are taxed.
- investments held in an HSA brokerage account, which will be used tax-free for medical expenses.
- My withdrawals from Traditional IRA accounts will count as income and allow me to qualify for insurance subsidies through the Health Insurance Marketplace.
- I can do Roth Conversions from my Traditional IRA accounts so I can pay little to no tax at the time of conversion and no tax when I withdraw. Thus I will have saved when I contributed and then paid little to no tax when I converted and pay no tax when I withdraw 5 years later.
I already did a Roth Conversion one year because I took a seven month break from work so I figured it was a good time to take advantage of lowering my future tax bill. That ended up being a great idea because five years after that I was able to use the funds to buy an investment property without paying any penalties on the distribution.
Things to Think About When Deciding
- How much income do you expect during retirement?
- Do you expect to have earned income aside from your IRAs?
- Do you anticipate needing health coverage from the Health Insurance Marketplace?
- What tax bracket are you currently in?
- What tax bracket do you anticipate being in during retirement?
- Do you need the flexibility to withdraw if necessary?
- Do you anticipate having lower income at any point and thus being able to do Roth Conversions?
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