Should I Make a Roth contribution or a Traditional IRA Contribution?

IRAs remain a great way to set aside funds for retirement, even though most people nowadays have access to a 401(k) or 403(b) retirement savings plan at work. One of the most common questions people have about IRAs is whether they should invest in a traditional or a Roth IRA? Given that many employer retirement plans now offer a Roth option as well, you may well be faced with the Roth vs. traditional contribution decision there as well.

There are important differences between traditional and Roth IRAs that you need to understand in order to make the best choice for you. Following is a brief explanation of each type of IRA and how they work to help you make the right choice. Additionally, if you’re more of a visual thinker, you might find this flowchart helpful in choosing between a traditional or Roth IRA contribution.

The Main Differences

Roth IRAs were first introduced in 1988 as an alternative to traditional IRAs for retirement savers. The differences between traditional and Roth IRAs mainly have to do with taxation.

Annual contributions made to traditional IRAs are tax-deductible if you meet certain criteria. This could lower your current taxes by lowering your taxable income. Also, contributions grow on a tax-deferred basis, which can increase the size of your investment portfolio by the time you retire.

Roth IRA contributions aren’t tax deductible so you’ll receive no current tax benefit when you choose a Roth account. But Roth IRAs offer another tax benefit that could be even more valuable for some people: Withdrawals are made tax-free when you enter retirement because you’ve already paid taxes on the funds.

With a traditional IRA, you’ll pay tax at your ordinary income tax rate when you start withdrawing funds in retirement. So your retirement savings likely aren’t going to go as far if the funds are held in a traditional IRA than they will if they’re held in a Roth IRA.

Deduction Now or Tax-Free Withdrawals Later?

The decision about a traditional or Roth IRA essentially comes down to which is more valuable to you: receiving a tax deduction now or withdrawing money tax-free after you retire?

This might come down to whether you believe you’ll be in a higher or lower tax bracket after you retire. Predicting future tax rates is a crapshoot at best, especially if you’re decades away from retirement. But many people end up in a lower tax bracket after they retire since their income is lower. In this scenario, contributing to a traditional IRA will likely result in lower overall taxes being paid.

On the other hand, not having to pay income tax on Roth IRA distributions in retirement could help you stretch out your retirement savings longer. This could be especially important to you if you’re concerned about running out of money before you die or you want to leave an inheritance for your heirs as they won’t pay taxes on Roth distributions either.

There are different withdrawal rules for traditional and Roth IRAs that could also factor into your decision. Withdrawals made from traditional IRAs before you turn 59½ are generally included in your gross income and subject to a 10% early withdrawal penalty. But you can withdraw Roth IRA principal (not earnings) penalty- and tax-free at any age and for any purpose. This is why some people use Roth IRAs as a supplemental college savings vehicle.

Required minimum distributions (or RMDs) from traditional IRAs are yet another factor to consider. In most situations, you must begin withdrawing money from a traditional IRA when you turn 72 years old because Uncle Sam won’t let you put off paying income tax on your retirement savings indefinitely.

However, there are no RMDs with Roth IRAs because the money has already been taxed. So if you don’t need IRA money to meet your living expenses during the early years of your retirement, you can leave the money in your account so it can continue growing tax-free throughout your lifetime.

Do You Qualify for a Roth IRA?

Keep in mind that there are income limits, so depending on your income you might not qualify to open and contribute to a Roth IRA.

If you’re married and file a joint tax return and your modified adjusted gross income (MAGI) is greater than $208,000 (or $140,000 if you’re single) in 2021, you are ineligible to open and contribute to a Roth IRA. If you’re married and file a joint tax return and your MAGI is between $198,000 and $208,000 (or $125,000 and $140,000 if you’re single) in 2021, you’re eligible to make a reduced contribution to a Roth IRA.

Also, depending on whether you have access to a retirement plan at work, you may or may not be able to deduct your traditional IRA contributions as this IRS chart illustrates. If neither you nor your spouse is covered by a retirement plan at work, you will generally be allowed to deduct your IRA contributions on your tax return. But if either of you is covered by a retirement plan at work, you might not be able to deduct your IRA contributions, depending on how much money you earn (you’ll find the IRS rules on this here).

As you can see, there are several different factors in the traditional vs. Roth IRA decision and these will vary from one person to the next. We can help you make the right decision based on your unique situation.