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What's Better? A Roth or Traditional IRA?

Both traditional and Roth IRAs can be effective retirement savings tools, but eligibility limitations mean one or both may not be right for you. Here’s a guide to help you choose.

What’s the difference between a traditional and Roth IRA?

A traditional IRA is an individual retirement account that allows you to make contributions on a pre-tax basis (if your income is below a certain level) and pay no taxes until you withdraw the money. This makes a traditional IRA an attractive option for investors who expect to be in a lower tax bracket during retirement than they are now.

On the other hand, Roth IRA contributions are made with after-tax dollars. The benefit of a Roth IRA is that you can withdraw your contributions and earnings tax-free after age 59½, if you’ve had the account for at least five years, or you meet certain other conditions.² In addition, your after-tax contributions to the Roth account can be withdrawn at any time, tax- and penalty-free. However, if you make an early withdrawal of any earnings, you will have to pay taxes and penalties on them.

A Roth IRA could be a strategic option for investors who expect to be in a higher tax bracket during retirement than they are now. It can also offer some spending flexibility in retirement, since you can withdraw money without increasing your tax bill and you won’t have to take annual required minimum distributions (RMDs), unlike a traditional IRA.

How much can I contribute?

The maximum amount you can contribute across all your IRAs (traditional or Roth) in 2020 is $6,000. The catch-up contribution if you’re age 50 or older remains $1,000. However, there are some rules that affect IRA contributions and deductibility.

For example, there is no income limit for contributing to a traditional IRA, and your contribution is fully deductible if neither you nor your spouse was covered by a retirement plan at work during the tax year. However, if either of you was covered by a workplace retirement plan, deductibility phases out depending on your filing status and income.

Contribution deduction eligibility for traditional IRA

Filing status (2019 tax year)Fully deductible if income is:Partial deduction if income is:No deduction if income is:
Single≤ $64,000> $64,000 but < $74,000≥ $74,000
Married filing jointly, filer is covered≤ $103,000> $103,000 but < $123,000≥ $123,000
Married filing jointly, spouse is covered≤ $193,000> $193,000 but < $203,000≥ $203,000
Married filing separatelyNA< $10,000≥ $10,000

Filing status (2020 tax year)Fully deductible if income is:Partial deduction if income is:No deduction if income is:
Single≤ $65,000> $65,000 but < $75,000≥ $75,000
Married filing jointly, filer is covered≤ $104,000> $104,000 but < $124,000≥ $124,000
Married filing jointly, spouse is covered≤ $196,000> $196,000 but < $206,000≥ $206,000
Married filing separatelyNA< $10,000≥ $10,000
Source: Internal Revenue Service

Unlike with a traditional IRA, you can only contribute to a Roth IRA if your income meets certain limits.

Income eligibility for Roth IRA contributions

Filing status (2019 tax year)Full contribution allowed if income is:Partial contribution allowed if income is:No contribution allowed if income is:
Single< $122,000≥ $122,000 but < $137,000≥ $137,000
Married filing jointly< $193,000≥ $193,000 but < $203,000≥ $203,000
Married filing separatelyNA< $10,000≥ $10,000

Filing status (2020 tax year)Full contribution allowed if income is:Partial contribution allowed if income is:No contribution allowed if income is:
Single< $124,000≥ $124,000 but < $139,000≥ $139,000
Married filing jointly< $196,000≥ $196,000 but < $206,000≥ $206,000
Married filing separatelyNA< $10,000≥ $10,000
Source: Internal Revenue Service

There are a few other advantages to a Roth IRA worth considering. You aren’t subject to RMDs with a Roth IRA, and it can be a flexible source of retirement funding. For example, you can withdraw a large sum if you have a one-time expense or other needs in retirement without increasing your tax bill. Allocating a portion of your retirement savings to a Roth IRA can increase the flexibility you have to manage taxes in retirement.

You can withdraw contributions anytime for any reason without tax or penalty. However, just because you can doesn’t mean you should. The opportunity costs are high—taking money out of your Roth IRA means you may miss out on the potential for compounding gains. And when you can put in only $6,000 for 2020 plus an additional $1,000 catch-up contribution if you’re age 50 or older, it might be difficult to make up the amount you withdraw.

Finally, we can’t know with certainty future tax rates. Contributing part of your retirement savings dollars to a Roth IRA after paying taxes can add tax diversification to your retirement savings in the event Congress increases tax rates in the future or when you retire.
Other things to keep in mind

Account rollovers

If you change jobs, you have the option to convert a traditional 401(k) directly into a Roth IRA without having to roll it into a traditional IRA first. Just remember you must pay federal income tax on pretax contributions and earnings at the time of the rollover. Also, remember that you may have other options, including keeping your assets in your former employer’s plan, rolling over assets to your new employer’s plan, or taking a cash distribution (on which taxes and possible withdrawal penalties may apply).

Roth 401(k)

An increasing number of employers are offering Roth 401(k) options in addition to traditional 401(k)s. With a Roth 401(k), you can contribute a portion or all of your paycheck up to certain limits. You can also choose to have some of your paycheck go pretax into a traditional 401(k) and some post-tax into a Roth 401(k). Any employer match or contribution, however, must go into a traditional 401(k).

Unlike with a Roth IRA, contributions to a Roth 401(k) are not subject to earnings limits. This means that if you aren’t eligible to contribute to a Roth IRA because your income is too high, you may be able to contribute to a Roth 401(k). Distributions from a Roth 401(k) are subject to the same general tax rules as a Roth IRA, with the exception of an RMD requirement. You can avoid this by rolling over a Roth 401(k) balance into a Roth IRA before your RMD age. So if you’re eligible, don’t forget the Roth 401(k) option if a Roth makes sense for you.

Roth IRA conversions

If you’re ineligible for a Roth IRA, some investors maximize contributions to a traditional IRA so they can convert to a Roth IRA. However, there are some caveats.

You can’t pick and choose which portion of traditional IRA money is converted. The IRS looks at all traditional IRAs as one when it comes to distributions, including Roth conversions. Traditional IRA balances are aggregated so that the amount converted consists of a prorated portion of taxable and nontaxable money. So making nondeductible contributions to a traditional IRA with the goal of later converting to a Roth IRA would likely work if you have little or no existing deductible IRA balance to muddy the waters. Still, any earnings leading up to conversion would be subject to income tax, which, as always, is best paid with outside funds.

High earners not eligible to make Roth IRA contributions could make nondeductible contributions to a traditional IRA and then convert to a Roth (sometimes called a “backdoor Roth conversion”). The process is similar to any other Roth conversion, but typically takes place very soon after contributing funds to a traditional IRA. There is some debate among tax professionals whether this conversion conflicts with the intent of the Roth conversion law, which was updated in 2010. The IRS has not formally weighed in on this topic, so beware that there may be some risks to this strategy. If the IRS decides to question the conversion, you may owe a 6% tax or other taxes for overfunding your Roth. For some investors, a backdoor Roth conversion could be a viable way to obtain the benefits of tax-free growth, as long as they’re comfortable with the potential uncertainty and work with a certified public accountant (CPA) or tax professional.

The bottom line

Both traditional and Roth IRAs are great long-term savings tools, so educate yourself on the differences and make an informed decision that fits with your retirement goals. Remember that tax laws are subject to change, so keep up with the latest news from the IRS. Also, be sure to talk with your CPA or tax professional about whether a traditional or a Roth IRA—or both—makes sense for you.

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