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Roth IRA vs Traditional IRA

It seems to be all about the battle of Roth IRA vs Traditional IRA these days. There are may strengths and potential weaknesses that each of theses accounts pose for you as an investor. As an important starting point let us qualify the current Roth IRA phaseout limits as well as Traditional IRA deduction income limits.

ROTH IRA Phase-Outs:

Tax filing status2021 income limit2020 income limit
Single, or head of household $125,000 up to $140,000$124,000 up to $139,000
Married, filing jointly $198,000, up to $208,000$196,000, up to $206,000

Traditional IRA Deduction Limits:

Tax filing status2021 income limit2020 income limit
Single or head of household w/ access to a workplace plan$66,000, up to $76,000 $65,000, up to $75,000
Married filing jointly w/ access to retirement plan$105,000, up to $125,000 $104,000, up to $124,000
Married filing jointly, where one spouse doesn’t have workplace retirement plan access$198,000, up to $208,000 $196,000, up to $206,000

Roth IRAs

In the battle of Roth IRA vs Traditional IRA accounts there has been a spotlight on Roth IRA accounts as the current trending celebrity. Roth IRA accounts are traditionally used for a retirement saver who expects that their income tax bracket will be higher later in life during retirement than at the time they are saving. The reason that this logic is used as one of the most common approaches to choosing if a Roth is right for someone is due to the tax-free withdrawals as long as the account meets the 5 year rule and you are 59 ½ or older. Therefore, if you are in a lower-earning phase of your career or you feel that tax rates have a risk of rising within your retirement lifetime in a way that could put you into a higher tax bracket; the Roth account will help you pay “today” rather than tomorrow.

Roth IRA contributions are made after-taxes and do not provide a tax write-off for you as the traditional IRA & 401(k) options would. More commonly in recent, Roth IRA accounts have taken center-stage for “Roth Conversions” – the conversion of traditional IRA funds into a Roth IRA status, paying today’s taxes while the TCJA has lowered current tax rates set to “sunset” back to the 2017 levels in 2025. It’s also been argued that tax rates are historically as low as they’ve ever been and the shortfalls on Social Security along with National Debt prime the tax tables for revisions upward in the future.

Finally, in your considerations of Roth IRA vs Traditional IRA options consider that Roth IRA accounts provide additional later-in-life benefits to you. Roth IRAs provide benefits due to not having RMDs & not causing additional estate taxes due to SECURE Act’s 10-year elimination of the stretch IRA. Both factors allow some additional control on withdrawals & legacy benefits. Furthermore, the presence of Roth IRA funds even with traditional IRA or 401(k) accounts allows for tax-diversification. This tax control allows you to better position IRMAA Medicare premium thresholds, Social Security Taxability, and overall tax liability cost over your lifetime in retirement.

Note: Roth 401(k) accounts are not subject to income phase-out limits and may be used by any participant. After-tax 401(k) contributions are also eligible means for “back-door Roth” contributions if you are phased-out. Note that after-tax funds in a traditional 401(k) are only tax free on the contributed total – NOT on it’s growth while in the plan.

Traditional IRAs

Our second contender in the Roth IRA vs Traditional IRA battle provides a “pay later” tax strategy. In qualifying cases, Traditional IRAs allow for deductible contributions (see table) that grow tax-free until their later use. When taken out, these funds are taxed as ordinary income and counted towards your gross income. These tax-deferred accounts can be most beneficial to those who expect to have a lower income tax rate in retirement. The ability to deduct income in the year of the contribution may also be a useful tool for those who are looking to control current tax liabilities.

One of the other benefits for higher income earners is the ability to have shelter from interest, dividend & capital gains taxes in either of the IRA account options reviewed here today. As part of your planning when using traditional IRA or traditional 401(k) accounts as part of your retirement strategy do not forget to include the RMD requirements that currently begin at age 72. In addition, it is important to remember that traditional IRA accounts do not allow withdrawals before the age of 59 ½ unless an exemption is applied. Should there not be an exemption such as disability, death, first time home purchase, qualified educational expenses, and others – there is a 10% penalty in addition to the income tax liability for the funds taken.

As previously mentioned during the Roth IRA benefits: traditional IRA accounts subject most non-spousal beneficiaries to fully withdrawal the inherited account balance within 10 years. This is a drastic change from the previous life-expectancy table that could be used for a “stretch” provision over the new account holder’s lifetime. Be sure to include the impacts on your estate beneficiaries tax liabilities should Estate planning for your heirs’ benefit is important to you when weighing Roth IRA vs Traditional IRA options.

What is the Verdict?

So, after putting these heavyweights in the ring who wins the Roth IRA vs Traditional IRA battle? The answer is not so clear cut, take into account the following:

When investing you are traditionally taught the benefits of diversification, by not “putting all your eggs in one basket” you spread risk. As discussed in our reviews of Roth IRA vs Traditional IRA considerations each account will benefit different phases of your earning years. In addition to this, the diversification of these accounts and their tax implications allows you as the investor far more control over the unpredictable future of tax law. In a rapidly changing world of retirement and tax litigation both accounts will give greater flexibility and benefits to you as the account holder. However, should you want to know how to best fit your specific situation, goals & future needs it is highly suggested to work on a comprehensive plan with a professional that can show you the potential benefits of these choices for you.

We offer a free consultation to help address your concerns and needs; schedule your call today to begin planning.

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