Roth vs. Traditional IRA

 If you’re planning to use an IRA to save for retirement, but aren’t sure if Roth or Traditional is best for you, we can help sort it out. First, before we begin breaking down the pros and cons of each type of retirement account, you need to be sure that you are eligible to make contributions to these accounts.

For 2014 Roth IRA contribution rules/limits:

  • For single filers the modified adjusted gross income (MAGI) is phased out between $114,000 and $129,000 (unsure what MAGI is? Click here)
  • For married filing jointly the MAGI is phased out between $181,000 and $191,000
  • Please keep in mind that for making contributions to this type of account it makes no difference if you are covered by a qualified plan at work (such as a 401k or 403b), you simply have to be under the income thresholds.
  • Maximum contribution amount is $5,500

For 2014 Traditional IRA contributions:

  • For single filers who are covered by a company retirement plan (401k, 403b etc…), in 2014 the deduction is phased out between $60,000 and $70,000 of modified adjusted gross income (MAGI).
  • For married filers, if you are covered by a company retirement plan in 2014, the deduction is phased out between $96,000 and $116,000 of MAGI.
  • For married filers not covered by a company plan but with a spouse who is, in 2014 the deduction for your IRA contribution is phased out between $181,000 and $191,000 of MAGI.
  • Maximum contribution amount is $5,500

If you are eligible, you may be wondering which makes more sense for you?  Well, like many questions in finance the answer is…it depends! 

Roth IRA Advantage

The benefit of a Roth IRA is that the money grows tax deferred and someday, when you are over age 59.5, you can take the money out tax free.  However, in exchange for the ability to take the money out tax free, you don’t get an upfront tax deduction from the IRS.  Essentially you are paying your tax bill today rather than in the future. 

Traditional IRA Advantage

With a Traditional IRA, you get an upfront tax deduction.  For example, if a married couple filing jointly had a MAGI of $180,000, (just below the phaseout threshold), then they would probably be in a 28% marginal tax bracket.   If they made a full $5,500 Traditional IRA contribution they would save $1,540 in taxes.  To make that same $5,500 contribution to a ROTH, they would need to earn $7,040, pay the taxes, and then make the $5,500 contribution.  The drawback of the traditional IRA is that you will be taxed on it someday when you begin making withdrawals in retirement.

Pay Now or Pay Later?

The challenging part about choosing which account is right for you is that nobody has any idea what tax rates will be in the future.  If you choose to pay your tax bill now (Roth IRA), and in retirement you find yourself in a lower tax bracket, then you may have been better off going the Traditional IRA route. However, if you decide to make Traditional IRA contributions for the tax break now, and in retirement you find yourself in a higher tax bracket, then you may have been better off going with a Roth. 

How Do You Decide?

A lot of it depends on your personal situation, such as the career path you’ve chosen and your desired income in retirement. However, we typically recommend that people just starting out in their careers who will probably earn a much higher income in the future make ROTH contributions.  If you’re in the 25-28% marginal bracket, a Traditional IRA may make more sense for the immediate tax break now.  As always, before making any final decisions, it’s always a good idea to work with a qualified financial professional to help you understand what makes the most sense for you.

Matthew Trujillo, CFP®, is a Registered Support Associate at Center for Financial Planning, Inc. Matt currently assists Center planners and clients, and is a contributor to Money Centered.

This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Any opinions are those of the Center for Financial Planning, Inc. and not necessarily those of Raymond James. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Roth IRA owners must be 59 ½ or older and have held the IRA for five years before tax-free withdrawals are permitted. You should discuss any tax matters with the appropriate professional.

Links are being provided for informational purposes only. Raymond James is not affiliated with and does not endorse, authorize or sponsor any of the listed websites or their respective sponsors. Raymond James is not responsible for the content of any website or the collection or use of information regarding any website’s users and/or members. C14-015057