Traditional vs. Roth IRAs – which is best for you?
Posted On: 8-3-2015 | Posted By: Debra Harrington, CPA
Choice is a good thing, but informed choice is even better! When it comes to selecting a retirement savings vehicle, you can choose between traditional and Roth Individual Retirement Accounts (IRAs), which have unique advantages and tax consequences. To get the most benefit from your savings, carefully evaluate the differences between traditional and Roth IRAs, consider your personal circumstances, and choose the IRA that works best for you.
The Roth IRA has several advantages over a traditional IRA.
- Roth IRAs provide tax-free growth, while traditional IRAs are tax-deferred. Because you are making contributions with after-tax dollars, Roth IRA earnings accumulate tax-free, and distributions are generally not taxable.
- Distributions from a Roth are considered to come first from contributions and then earnings. There is generally never a tax on distributions from contributions, and there is no tax on distributions from earnings after a five-year holding period and after age 59 ½. Therefore, even if a distribution is made from a Roth before reaching age 59 ½ and the five year holding period isn’t met, there will be no tax or penalty up to the amount of contributions in the account. Contrast this with a traditional IRA, in which distributions are made proportionately between contributions and earnings, and “early” distributions would be subject to tax and penalties.
- Roth IRAs do not have required minimum distribution (RMD) rules until the death of the account owner. While traditional IRA accounts require minimum distributions at age 70 ½, taxpayers are not required to take any distributions from Roths during their lifetime. A surviving spouse of the Roth, if the only beneficiary of that Roth, can elect to treat the inherited account as their own, and they also do not have to take distributions during their lifetime. However, other beneficiaries of Roths must take required minimum distributions.
- Beneficiaries of Roth IRAs do not pay income tax on withdrawals. They do pay tax on inherited traditional IRAs. Similar to the account owner, traditional IRA distributions are fully taxable when distributed to a beneficiary. Roth IRA distributions made to a beneficiary generally are not taxable as long as the five year holding period mentioned above has been met by the deceased.
- Taxpayers who will be in a high tax bracket when distributions begin benefit from a Roth. If a taxpayer expects their income will not be much lower after RMDs begin, or doesn’t expect to need to take distributions, a Roth might be beneficial.
- As long as taxpayers still have earned income, contributions can be made to a Roth after age 70 ½. That is not the case with traditional IRAs. Even if a tax taxpayer is still working, traditional IRA contributions are not allowed after a taxpayer reaches the RMD age.
A traditional IRA offers a distinct advantage over a Roth: it provides a tax deduction, resulting in lower income taxes. This is a better choice if you expect to be in a lower tax bracket when you retire and need to withdraw the funds. The money saved on taxes can be used to help fund the IRA.
Some of the rules that apply to traditional IRAs also apply to Roth.
- Contributions must be made by the original due date of the taxpayer’s tax return.
- There is a 6% penalty on excess contributions.
- There are income phase-outs for contributions.
- The maximum contributions limits are the same for both.
Unless your crystal ball works better than ours does, it is impossible to know what the future holds for you: what your tax bracket will be upon retirement, how long your retirement will last, or how Congress might change IRA rules before you retire. What you can do is keep yourself informed and work with your WK advisor to decide what type of IRA to fund. We can also help you decide whether a conversion from a traditional to a Roth IRA makes sense for you. Contact us at (573) 442-6171 or (573) 635-6196 to speak with your advisor regarding your IRA options.