Traditional vs. Roth IRA: Which is Right for Me?

May 8, 2014 11:40:29 AM / by Jason Shaw

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If you do not have access to an employer-sponsored retirement account, an IRA is a great alternative.  Whether a Roth or traditional IRA will be most beneficial for you depends upon your individual financial situation, including your current and projected income levels and the likelihood that you will need to access your funds before you reach retirement age.  A breakdown of the features of each type of IRA will help you select the best version for you.

Eligibility

The first question to ask is to what type of IRA, if any, you are eligible to contribute.  While Roth IRAs are available to savers of any age who have taxable compensation that falls with defined income limits, traditional IRAs are restricted to those under age 70 ½ but available to people of all income levels.

The income limits for contributing to a Roth IRA depend on your filing status.  Additionally, incomes that fall within a certain range lower the maximum yearly amount a saver may contribute.  Guidelines for figuring reduced contribution limits can be found on the IRS website. The limit for IRA contributions for tax year 2014 is $5,500 for those under 50 and $6,500 for those 50 and older.  Income is measured by modified adjusted gross income (MAGI), which is found by adding certain deductions and foreign income to the adjusted gross income (AGI) reported on line 37 of Form 1040.

 

Roth IRA Income Limits, 2014

Filing Status

 

MAGI

Allowable Contribution

Married filing jointly Below $181,000

$181,000- $191,000

$191,000 or over

Up to the limit

A reduced amount

0

Married filing separately (if lived with spouse any time during the year)  

Below $10,000

$10,000 or over

 

A reduced amount

0

Single, head of household, or married filing separately (if did not live with spouse during the year)  

Below $114,000

$114,000-$129,000

$129,000 or over

 

Up to the limit

A reduced amount

0

 

Tax Treatment

If you are eligible to contribute to both Roth and traditional IRAs, then you need to decide which would be most advantageous to you.  To do this, you must consider the different tax treatment of the two types of retirement accounts.

A traditional IRA allows you to take a tax deduction for all or a portion of your contributions.  If neither you nor your spouse is covered by a retirement plan at work, then you can deduct the full amount of your allowable contribution.  If you (or your spouse) is covered by an employer-sponsored plan, however, the amount you can deduct may be limited.  See the IRS website for details on these limitations.  Although you may deduct contributions to a traditional IRA, withdrawals are taxed at the time they are made.

Contributions to a Roth IRA are not tax deductible, but withdrawals are made tax-free.  Which tax treatment will benefit you more depends upon your current and projected income level and tax bracket.  If you currently have a substantial tax obligation, then the deduction associated with a traditional IRA can be very helpful.  If, on the other hand, your current tax obligation is minimal or nonexistent, then you may see little or no benefit from claiming the deduction; you may see greater benefit from withdrawing your funds tax-free in retirement.  If you are unsure which will be the best option for you, get advice from a financial services professional.

 

Availability of Funds

Another critical factor in determining whether a traditional or Roth IRA is the best choice for you is how likely it is that you will need to access the funds before you reach retirement age.  If you are concerned that you may need the money you would like to contribute to your IRA for other things, then a Roth is your safest bet.  You may access your contributions to a Roth IRA (but not their earnings) at any time and for any reason without penalty.  In order to access earnings on a Roth IRA without penalty, generally speaking, the account must be open for a minimum of five years, and you must be at least 59 ½ years old.

Funds in a traditional IRA are qualified for withdrawal only after age 59 ½ or in specific circumstances that qualify as exceptions, such as disability, paying for qualified educational expenses, substantial unreimbursed medical expenses, or purchasing a first home.  Taking non-qualified distributions subjects you to income tax and an additional 10% penalty.  For this reason, it is best to put money into a traditional IRA only if you are relatively certain that you can live without it until you reach retirement.

Choosing the best retirement account can be a complex task.  For help understanding your choices and how each may benefit you, speak with a retirement services professional.  Boelman Shaw Capital Partners offers a full range of financial services to our Des Moines area clients, including retirement and other financial planning services, tax planning and preparation, insurance, and business services.  Our comprehensive range allows us to get a more complete picture of each client’s unique financial situation and provide advice that is specifically tailored to meet their individual needs.

 

Material discussed herein is meant for general illustration and/or informational purposes only.  Because individual situations will vary, the information shared here should be used in conjunction with individual professional advice.

Topics: Financial Planning

Written by Jason Shaw