Deciding to contribute to a retirement account is almost always a smart choice. But which type of account is the best investment for your particular situation? The answer to this question depends on a number of factors, and it is always best to seek professional assistance from someone who fully understands the pros and cons, and who is familiar with your unique situation. However, before you visit a Provo accounting firm, read the blog below to get a general idea between two very common types of retirement accounts—Roth IRAs and Traditional IRAs.
Though the contribution limits for Roth and Traditional IRAs are the same, and therefore not generally a factor in deciding which to contribute to, here are the 2018 contribution limits:
- If under 50 years of age, the contribution limit is $5,500.
- For anyone 50 years or older, the contribution limit is raised to $6,500.
It’s important to know this upfront, so that you can appropriately plan other types of retirement contributions for the year.
The type of IRA you can contribute to may be limited by your income. Only tax filers who earn below a certain AGI (Adjusted Gross Income) can contribute to Roth IRAs. Here are the income limits for 2018:
- For single tax filers, the income limit is $135,000 (phase-out begins at $120,000).
- For married couples filing jointly, the income limit is $199,000 (phase-out begins at $189,000).
If you earn more than the limits given above, you won’t be able to contribute to a Roth IRA. However, Traditional IRAs have no contribution limits, so you will likely still be able to make contributions to this type of account. It is important to note though that the deductibility of your contributions to a Traditional IRA may be limited by your income, or participation in an employer retirement plan.
With Traditional IRAs, you cannot withdraw from the account before the age of 59 ½ without paying penalties. There are a few exceptions to this (up to $10,000 for a first-time home purchase, and certain qualifying education and hardship expenses), but typically, you will need to wait until 59 ½ to make any withdrawals. After the age of 70 ½, you will be required to take minimum disbursements from the account. Any beneficiaries of a Traditional IRA must pay taxes on the amount the inherit from it.
For Roth IRAs, you can withdraw any contributed amounts at any time, with no taxes or penalties; after the age of 59 ½, and at least 5 years after your first contribution, the earnings you’ve received from the Roth IRA may also be withdrawn, free of taxes and penalties. You are not required to take disbursements from a Roth IRA during your lifetime, and beneficiaries of this account can spread out disbursements over many years. So, if you’re hoping to use your IRA as a means of transferring wealth to your heirs, Roth IRAs are a better option.
Tax Deductions and Benefits
For many people, the real decision-maker between these two types of retirement accounts lies in the tax breaks they offer. While both offer some sort of tax benefit, the difference between the two is in when you will receive that benefit.
Roth IRAs are an after-tax contribution. This means that, when you retire, you will be able to withdraw funds from your Roth IRA without paying taxes on it. This provides you with a source of tax-free income when you might be living on a much lower, fixed income than what you received while working.
Traditional IRAs, on the other hand, provide an immediate tax benefit. The amount that you contribute to a Traditional IRA is deducted from your taxable income, which reduces the amount that you owe (or increases the amount of your return), and may even push you into a lower tax bracket. However, when you retire and begin taking withdrawals, you will need to pay taxes on any money you receive.
Deciding between these two benefits can be difficult, and will depend on many factors—most importantly, whether you believe you will be in a higher tax bracket later in life, or a lower one. Of course, this can be hard to predict, and may actually change from year to year.
With so many factors influencing this decision, it’s important that you consult with a Provo accounting firm when deciding which type of IRA to contribute to. If you need assistance, contact Biesinger & Kofford CPAs. We’ll be able to offer you guidance based on your current financial situation, your goals, and your current tax bracket.