Roth IRA or Traditional IRA
Taxes Now, or Taxes Later?
While it’s great to have options, trying to choose between a Traditional IRA and a Roth IRA—for some—can be frustrating and confusing. What are my options? What type of IRA is best for me? Millions of taxpayers struggle with these questions each year.
The good news? Once you break the decision process down into smaller steps, you’ll find the decision isn’t nearly as overwhelming as it first appeared.
It’s All Good
When trying to choose between a Traditional IRA and a Roth IRA, it’s important to note that the choice doesn’t have to be an all or nothing proposition. Assuming you meet the funding eligibility requirements, you don’t have to choose one option over the other (although your aggregate contributions must be within the prescribed annual funding limit). Traditional IRAs and Roth IRAs are both tax-advantaged savings vehicles that can help you achieve a more financially secure future.
First Things First: Eligibility
The funding eligibility rules for Traditional IRAs and Roth IRAs are different. So, the first step you should take when trying to decide on an IRA savings strategy is to determine what options are available to you.
Traditional IRA Funding Eligibility
To be eligible to fund a Traditional IRA, you typically must have earned income. Just because you are eligible to fund a Traditional IRA, however, does not automatically mean that you qualify to take a tax deduction for your contribution. If either you or your spouse participate in an employer-sponsored retirement plan, your ability to take a tax deduction for your contribution will depend on your income level and tax filing status.
Roth IRA Funding Eligibility
To be eligible to fund a Roth IRA, you typically must have earned income and your income must not exceed the applicable funding eligibility threshold (which varies based on your tax filing status). Unlike Traditional IRA contributions, which are oftentimes tax deductible, Roth IRA contributions are always made with after-tax dollars (i.e., they are never tax deductible).
Deductible Traditional IRA or Roth IRA?
If you’re eligible to make a fully deductible Traditional IRA contribution and a Roth IRA contribution, a key factor for you to consider is whether you’d prefer to pay taxes now, or pay taxes later. When choosing to fund a Roth IRA, you’re opting to pay taxes now (i.e., your contribution is not tax deductible) in exchange for the anticipated future benefit of avoiding taxes when you take withdrawals in retirement. On the other hand, if you choose to fund a Traditional IRA (with a fully deductible contribution), you’re opting for an immediate tax benefit in the present knowing you’ll eventually have to pay taxes on your contributions and earnings in the future when you take withdrawals in retirement.
Nondeductible Traditional IRA or Roth IRA?
If you find that you’re eligible to fund a Roth IRA but your funding eligibility for a Traditional IRA is restricted to nondeductible contributions, the Roth IRA option will generally provide a greater tax advantage. Under this situation, you are comparing two IRA funding options that are both made with after-tax contributions with only one option (the Roth) providing the opportunity for tax- free withdrawals at retirement.
Additional Factors to Consider
In addition to the basic issue of paying taxes now or later, there are a variety of other factors you should consider:
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