How should I decide which type of IRA (traditional or ROTH) is best for my needs?

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  • 4 out of 4 people found this answer helpful

    CRPC Palo Alto, CA

    Since a regular IRA provides a current year tax deduction it may be the better choice.  But the Roth could be a better option if you are in a lower tax bracket.  If your tax bracket is below 25% then you might want to consider a Roth since a current year tax deduction wouldn't be as beneficial for you as it would if you were in a higher income tax bracket.  Each individual is unique so consider consulting with a financial advisor for a thorough evaluation.

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  • 5 out of 6 people found this answer helpful

    CFP® Palo Alto, CA

    In addition to the excellent answers provided by the other advisors here, I'd like to elaborate a little bit on the point regarding early withdrawals, as well as a quick point regarding estate taxation.

    Direct contributions to a Roth IRA may be withdrawn without tax or penalty at any time.  No such provision exists for traditional IRAs.

    Distributions from a Roth IRA may be "qualified" or "non-qualified" (mainly related to whether you are over or under 59.5 when you take the distribution, but there are other qualifying circumstances as well).  Non-qualified distributions may or may not be taxed or penalized, depending on the source of the distribution.

    Regardless of the order in which money is added to the Roth IRA, the IRS uses "ordering rules" to apply to the distributions, and they come out in the following order: 1.  all regular participant contributions; 2. taxable conversions/rollovers; 3. non-taxable conversions/rollovers; 4. earnings on any of the previous contributions.

    To the extent that a non-qualified distribution is just the return of regular participant contributions, the distribution is nether taxed nor penalized.

    Additionally, taxable conversions/rollovers, since taxes are paid at the time of conversion/rollover, do not get taxed, and if it's been 5 years or more since the conversion/rollover, there's no penalty, either.

    The upshot of all this is that if you are able to make direct participant contributions to a Roth IRA, there's no downside - you can always get that money back out without taxes or penalties.


    As far as estate taxation, while this is a lot less of a concern now with the very much higher estate tax exemption (over $5 million per person), if there is any expectation of the estate being taxed, it's much better to have Roth assets rather than traditional IRA assets inasmuch as the estate tax applies to the account value without regard to the fact that the money is pre-tax or after-tax (traditional vs. Roth).  Which means that if you have $1000 in a traditional IRA and you face estate taxes, you owe estate taxes on that full $1000 -- even though after the death in question, you'll pull that $1000 out and pay incomes taxes *again* on it.  In other words, if your heir's marginal tax rate is, say, 30%, then you'll be paying estate taxes on the $300 which is the part which will be going to pay income taxes.  Taxes on taxes.  If the owner had $700 in a Roth IRA rather than the $1000 in a traditional IRA (assuming same marginal tax bracket), then only $700 would be subject to estate taxes - no estate taxes apply to the part which was already spent paying income taxes.

    Again, the estate tax issue is not going to affect nearly as many people now as it would have had they not come to terms making the higher exemptions permanent, but it is something which was a big issue a few years ago, and which high-net-worth folks should remain aware of.  It makes it worthwhile for high net worth folks to consider Roth conversions and paying taxes now, even at higher marginal rates than their heirs may eventually face.


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  • 2 out of 2 people found this answer helpful

    CFA, CFP® San Francisco, CA

    The essential difference between a traditional IRA and a Roth IRA is when the taxes are due on the money you deposit into the account and the earnings which they produce over time through investing. Thus, your determination of your personal tax status today versus your future tax status when you will be taking withdrawals will make a Roth more or less attractive. There are also other considerations, to be sure.

    Because a traditional IRA allows deductible contributions, you avoid paying income tax today on the money you put in. When you are of the age where you must begin withdrawing from the account, all of your withdrawals, both your original contribution as well as earnings, will be taxed as ordinary income. The higher your present day marginal tax rate is relative to your future marginal tax rate, the more attractive it is to utilize a traditional, deductible IRA. You are shielded from the tax man today, and revisiting him when you are in a lower bracket in the future. Future tax rates are unknown and could go way up across the board, of course. The older you are when making the contributions, the more favorable the traditional IRA results are relative to the Roth. You benefit from the immediate tax deferral, and have more certainty about future tax tables and your own tax status because you have better ability to forecast over the short term.

    If you qualify (eligibility to contribute phases out at certain income limits), the Roth IRA allows you to pay income taxes today on your contributions today. In the future you will withdraw both your original contribution amount and additional earnings tax free. You don’t need to know what the future holds for tax rates because you already will have paid them years earlier. The higher that tax rates become in the future, or the higher your own income becomes, the greater the benefit of that tax free income becomes. Unlike the Traditional IRA, the younger you are, the more valuable the Roth choice is. The reason is that you will be starting with fewer investment dollars after paying out taxes from your contribution just prior to investing it, leaving you with a smaller starting amount. It takes many years of compounded earnings before the tax advantage at withdrawal overcomes that initial handicap. Furthermore, if you should drop into a much lower bracket when you want to withdraw money at the minimum age of 59.5 or beyond, you will lose some of that tax advantage, having already paid the taxes when you were in a higher bracket.

    There are other advantages to the Roth IRA, however. One is that you do not have to take mandatory withdrawals beginning at age 70.5, which you do in a Traditional IRA. That becomes yet an additional way to stretch tax deferral. This extra option has a lot of value if you do not actually need the money for spending. The account can continue to grow until you do need it, without forcing extra income taxes on you through mandatory withdrawals, as a Traditional IRA does. Do not fail to research other special rules allowing for early penalty free withdrawal options of a Roth which are not found in a Traditional IRA account.

    In summary, you should make your choice about paying taxes now or later based on your own unique circumstance and outlooks. Utilize an online calculator, if you like. You will see that the longer the time you have for your contributions to grow, the more attractive the Roth option will be. The shorter the time, or the more likely you will need to withdraw from the account in retirement, the more valuable the Traditional IRA will be. Tax rates today are a known quantity. Future tax rates are unknown. If you want to assume that future taxes are going only up, the Roth becomes more valuable to you. If you think taxes will be static, and that you personally will be in a lower bracket someday, the Traditional IRA is more valuable. (Answer: with an aging population, large Federal budget deficits, and state and local implicit future obligations, taxes are going up from here!)

    If you think it is foolish to make either choice, consider owning both types of accounts at the same time, and take partial advantage of the features of each.


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    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
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  • 2 out of 3 people found this answer helpful

    CFP®, MSFS San Luis Obispo, CA

    Here's a simpler answer for everyday people -

    A regular IRA is taxed at the time you take the money OUT (ideally in retirement). A Roth IRA is taxed at the time the money is put into the account.

    If your income tax rate is lower today than it will be when you are going to take the money out after age 59.5 (example, you are young with lots of pay increases in your future), then it would be crazy to avoid paying taxes today at a low tax rate so you can pay taxes on that money in 40 years at a much higher rate.

    If on the other hand you are close to retirement and near your peak earning potential, then that tax rate on the deduction now will be higher than the one you are likely to pay after you retire.

    In the end, ideally you want fairly equal amounts in traditional IRA's, Roth IRA's and regular investment accounts.

    Of course with the details of your case, it wouldn't hurt to pay a fee-for-service CFP® professional for a more precise answer.

    Was this a helpful answer?

    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
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  • 2 out of 3 people found this answer helpful

    ADPA, CFP®, CRPC Denver, CO

    IRAs come in two types:
    Traditional and Roth. To determine which one is best suited for your annual contribution,
    here are some key factors to consider:

    Advantages to a Traditional Deductible IRA:

    • Tax Deductible:  Your contribution is deductible on your federal income tax return for the year in which you contribute. 
    • Tax-Deferred Growth:  Your contribution grows tax deferred until you withdraw the money. This means you do not pay any taxes while your money is growing.

    Limitations to a Traditional Deductible IRA:

    • Adjusted Gross Income (AGI) Limitations:  The amount you can deduct is limited based on your AGI and if you participate in your employer sponsored retirement plans. Your contribution may be fully deducted on your income taxes, partially deducted or not deductible at all.
       
    • 10% Penalty:  The 10% penalty is used to encourage IRA owners to keep their money in their IRA until reaching age 59 ½. If you
       withdraw any of your money prior to age 59 ½, then you will incur a 10% penalty on your withdrawal amount. There are some exceptions to the rule: educational expenses, first time home purchase and certain medical
      expenses.

    Advantages to a Roth IRA:

    • Avoid Taxes in the Future:  Roth IRAs grow tax free. Therefore no taxes are due when you withdraw your money. 
    • No Required Minimum Distributions (RMD):  Roth IRAs do not require RMDs after age
      70 ½, so your money can continue to grow with the potential for larger dollar amounts to leave to heirs.

    Limitations to a Roth IRA:

    • Adjusted Gross Income (AGI) Limitations:
      For high wage earners (2013 limits for single filing over $127,000 and married filing jointly over $188,000), Roth contributions are not allowed. 
    • Disqualified Distributions:  The earnings in your Roth must remain in the account for 5 years (known as the 5 year clock) and until you reach 59½ years old. A 10% penalty will be applied on earning distributions that do
      not meet these requirements.

    Always consult a financial planner or IRS publication 590 before you make your final IRA decision. Making the correct IRA choice now can benefit you down the road in your retirement.




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    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
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  • 1 out of 2 person found this answer helpful

    CFP® Leesburg, VA

    It's the rare person who can't benefit from having differently taxed accounts in retirement.  Plan to have taxable, tax-deferred and Roth accounts at retirement.  This way you can devise strategies for withdrawals that make sense when you are withdrawing.

    Was this a helpful answer?

    Advisors offer free consultations to determine if you're a good fit for one another. Providing more information in the consultation request will help advisors have a better sense of what you're looking for. The advisor will contact you via email and set up a time to meet. Depending on the advisor, and your preferences, this could be an in-person or online meeting. You are under no obligation to engage them after meeting with them.
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