Roth or traditional IRA? Income level and taxes could help you decide

It’s never too early to begin planning for retirement or investing in a nest egg for the future. There are several options available for investing in retirement plans, but the two we get questions about most often are whether a traditional or a Roth IRA is the best option. Deciding which is the best vehicle for you essentially comes down to income and taxes.

Traditional IRA

Traditional IRAs allow the investor to deduct contributions and in turn get a tax break for the year the contribution is made. For 2019, a traditional IRA is fully deductible if:

  • Neither you nor your spouse participates in an employer-provided retirement plan; or
  • If either you or your spouse does participate in an employer-provided retirement plan but your income is less than $123,000 if filing jointly or less than $74,000 for an individual.

If your income exceeds these limits, you can still contribute to a traditional IRA, but the deductibility phases out.

The contributions to a traditional IRA are made with pre-tax dollars; therefore, distributions are treated as income and may be subject to taxes. There are also penalties if the funds are withdrawn before you turn 59 ½.

The contribution limits for 2019 are up to $6,000 a year plus an additional $1,000 if you are 50 or older by the end of the year.

You can no longer make contributions to a traditional IRA beginning the year you turn 70 1/2. Furthermore, distributions from the traditional IRA are required by April 1 of the year following the year you reach age 70 ½. This means you must begin adding the required minimum distribution amount to your income and work with your tax adviser to plan for any tax implication.

Roth IRA

The primary differences between a traditional and a Roth IRA are income level and when the taxes apply. You can make annual contributions to a Roth in 2019 if your modified adjusted income is below $137,000 for single filers or $203,000 for married filing jointly.

The contribution limits for 2019 are the same for Roth IRAs as they are for traditional IRAs (up to $6,000 a year plus an additional $1,000 if you are 50 or older by the end of the year).

With a Roth, though, contributions are made with after-tax dollars and they cannot be deducted from taxes. What this means in practice is the Roth IRA distributions are tax-free and penalty-free if they are paid out after a five-year period that begins with the first year for which you made the contribution to the Roth and if the distributions is the result of any one of the following conditions:

  • You reach age 59 ½;
  • You are disabled;
  • Your beneficiary receives the distribution upon your death; or
  • You use up to $10,000 lifetime for first-time homebuyer expenses for you, your spouse, child, grandchild or ancestor.

If you do not meet the dual conditions but still need to withdraw funds from your Roth IRA, the amount of your contributions will not be taxed, but the balance of the earnings will be taxed and subject to a 10 percent penalty.

Other distinctions between a Roth and a traditional IRA are there is no age limit for contributions with a Roth and no mandatory minimum distribution.

If you have a traditional IRA but think you would like to convert all or a portion of that investment to a Roth IRA, you can complete a “roll over” of those funds. The amount taken out of the traditional IRA for the Roth will be treated for tax purposes as a regular withdrawal, but you will not incur the 10 percent early withdrawal penalty.

If you would like more information about which retirement plan is best for you, please give us a call.

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