When a Traditional IRA Makes Sense on a Roth Account
Saving in an IRA makes sense whether or not you have a retirement plan at work, but investors then have to decide whether a traditional or Roth account is better — as always, it depends.
Retirement Tip of the Week: Roth accounts are a great choice for young workers grounding their earning potential, but there are a few reasons why traditional IRAs may be the better financial choice.
MarketWatch is hosting a virtual “Master Your Money” event, which will include sessions on a variety of important personal finance topics. In one session, reporters and editors will tackle some of the most controversial decisions in personal finance, including when to invest in a traditional IRA or a Roth IRA, whether leasing or buying a car is makes more sense and why you may or may not want to go with a health savings account. Join us to watch the Financial Face-Off session on Wednesday April 20 here.
Traditional IRAs are especially useful for people who expect to be in a lower tax bracket in retirement, since contributions are made on a pre-tax basis (so taxes are paid on money going out, not on the money coming in). Of course, that’s not always easy to estimate – if you’re retiring in the next few years, you might have a better idea of what your tax bracket will be, but if you’re a few decades away, it It’s hard to know what your personal financial situation will be or what tax laws the government might change.
Another reason to opt for a traditional IRA: they can be tax-deductible, although it depends on whether you are enrolled in an employer-sponsored retirement plan (like a 401(k) plan), your tax status and that of your spouse or spouse. income limits. This tax deductibility can be quite powerful during tax season, however – according to one analysis, if you’re in the 32% tax bracket and contributing to the $6,000 annual limit, that could be up to $1,000 off your tax bill.
You also have until tax day to make a contribution on behalf of last year’s IRA, so if your Uncle Sam tax bill is a little higher than expected and you don’t have not yet contributed the maximum into your IRA last year, you can tell your investment firm to make your final contribution to last year’s account. Just be sure to tell the company hosting your account – otherwise the contribution will automatically go to your IRA for the current year – and make sure this is done before tax day (for this year , this deadline has passed).
There are many rules associated with traditional and Roth IRAs. For example, you must be 59½ to withdraw freely from either account, but you must also begin withdrawals from your traditional IRA before age 72, known as required minimum distributions. . Roth accounts have no RMD. Congress is also considering raising the age of required minimum distributions in its follow-up legislation to the Secure Act, which passed in 2019.
Also see: Got $50 more? $100? Even $20? Use it on an IRA for your future retirement (maybe even sooner)
Not everyone agrees that traditional IRAs are the right way to go, like personal finance speaker Suze Orman. And Roth accounts also have their own benefits – for example, investors can tap into these accounts before age 59.5 if they only withdraw their principal. They will only pay taxes and penalties on the income from these accounts.
Both accounts, however, allow for penalty-free distributions, such as death or disability, of up to $10,000 for first-time home purchases and qualifying education expenses. It is important to know the rules of a traditional IRA or a Roth IRA to avoid paying more penalties and taxes than necessary.
And don’t forget, if a Roth ultimately seems like a more attractive offer but you’ve been investing in a traditional IRA this whole time, it’s possible to convert some of your assets to Roth. You will have to pay conversion taxes at the time of this conversion, but it could be worth it if you are already in a low tax bracket and expect to be in a higher tax bracket by the time you distribute these funds .