The traditional IRA and the Roth IRA offer ways to save for retirement, although each offers different benefits and advantages. This article explores the important decision variables when choosing between the 2, as well as the impact of each on your current vs. future tax liabilities.
The traditional IRA allows an individual with earned income to take a tax deduction for dollars contributed (if income falls below a certain threshold), and the growth in the account is tax deferred. When distributions are taken from a traditional IRA, they are taxed as ordinary income. If one chooses not to take distributions from an IRA after reaching 59½, the IRS will force distributions to be taken at age 73. These are known as required minimum distributions (RMDs) and are based on the presumable retiree's life expectancy.
In order to take the deduction in 2024, an employee who is covered by a workplace retirement plan (such as a 401(k) or a similar plan) must make less than $77,000 to $87,000 as an individual or $123,000 to $143,000 as a married couple. If one of two spouses is covered by an employer-sponsored plan, the income limits for the household are increased to $230,000 to $240,000, and if no one in a household is covered by a plan, there is no income limitation in order to deduct contributions to a Traditional IRA.
For the ranges specific above, traditional IRA contributions are subject to an income phase-out rule. For example, if you're an individual tax filer, and your income is $77,000 or less, you can receive the full deduction for your contribution. If you're income is greater than $77,000 but less than $87,000, the contribution you make will be partially deductible. If you make more than $87,000, you aren't eligible to claim a deduction when filing your taxes.
The 2024 contribution limit for a traditional IRA is $7,000 with an extra $1,000 catch-up contribution for those 50 and over.
The other option is a Roth IRA. The Roth IRA was established as an account into which after-tax dollars are invested. While the Roth gives no tax deduction on the front end, the growth—and eventual distribution—is federal tax-free. The Roth IRA allows one to take out 100% of contributions at any time for any reason with no taxes or penalties. It is only the growth on which one must wait until the age of 59½ to draw penalty-free. There is also a 5-year aging period, which means that a payment made from a Roth IRA account is considered a qualified distribution if it is made after a 5-year period, beginning with the first taxable year after which a contribution to the Roth IRA occurs. There are exceptions for death or disability, and there is a one-time $10,000 qualified distribution for first-time home buyers.
As of 2024, if you make less than $146,000 for a single individual or $230,000 for a married couple, you can contribute $7,000 per person ($8,000 for individuals age 50 or older).
For 2024, if you make between $146,000 and $161,000 for an individual or $230,000 and $240,000 for a married couple, your allowable Roth contribution is phased out, and if you make over those top thresholds, you're not able to contribute to a Roth IRA.
One decision variable to keep in mind in deciding between a traditional IRA versus Roth IRA is income tax levels in the future. Most of the income generated by those in retirement is taxable. Even though at its inception Social Security income was promised not to be taxed, now up to 85% of one's Social Security retirement benefit could be taxed, depending on income. Pension income is taxed, although some states do not tax recipients of some pension income to draw retirees to their state. And, of course, tax-deductible contributions to 401(k)s and IRAs are going to be taxed in the year in which you take a distribution.
If you anticipate a higher rate of tax in the future, the Roth might be the best option. However, for those currently in their peak income earning years and expecting a lower tax rate in retirement, the traditional IRA may be a better choice.
Consider your unique situation in weighing both options. There are pros and cons to each retirement account, but ultimately the decision should be based on your own situation with special attention paid to your age and where you are in your career (peak income years versus retirement years).
