IRAs: Traditional or Roth?
There are more retirement account options today than ever, including traditional IRAs and Roth IRAs. Compare the features, benefits and rules of each to help you decide which one is right for you. It’s possible you may have both types of accounts to help maximize savings and minimize taxes you owe.
Let’s start by reviewing a few of the key features of the traditional IRA and the Roth IRA, along with their differences.
A traditional IRA allows you to contribute earned income each year into an individual retirement account. Your contributions are not limited by how much you make annually, but they may not be fully deductible. Subsequent distributions from the account are generally taxed at the prevailing ordinary income tax rates at the time of withdrawal. Roth IRA contributions are made with after-tax dollars, and the distributions—including any accrued income/gains—are generally tax free.
Both traditional and Roth IRAs have limits on the amount and timing of contributions into the account. For 2023, the combined annual contribution limit for Roth and traditional IRAs is $6,500 ($7,500 if age 50 or older).1 Individuals can continue to contribute to traditional IRAs after they turn age 70½ and if they have earned income.
Roth Earned Income Limitations
With a Roth IRA, there are income-eligibility rules. For 2023, single tax filers must have a modified adjusted gross income (MAGI) of less than $138,000 to contribute up to the contribution limit to a Roth IRA. Per the IRS, contribution limits are phased out (reduced) when MAGI is $138,000 to $153,000 for single and head of household filers. If you are married and filing jointly, you must have a MAGI of less than $218,000 in 2023 to contribute to a Roth. Contribution limits are phased out when MAGI is from $218,000 to $228,000.1
In regard to distributions, only the traditional IRA has required minimum distributions (RMDs). Both types of IRAs involve potential penalties if money is withdrawn before age 59½. Importantly, there are no required minimum distributions from the Roth IRA.* This additional deferral opportunity can be a significant advantage in terms of asset accumulation. Another benefit is tax-free distributions to beneficiaries. In the case of a traditional IRA, your beneficiaries will pay the income tax on their required distributions.
Which IRA Makes Sense for You?
Whether a traditional or a Roth IRA is the better choice for you or if having both types of accounts makes sense depends on a number of factors, such as your life expectancy, current and future income and tax brackets, cash needs in retirement and the tax status of your beneficiaries. Generally speaking, for those in a high tax bracket today, the contributions that can be made to a traditional IRA can be highly beneficial in lowering annual income amounts for income tax purposes, assuming you qualify for a tax deduction. Many people in this category will also benefit from a traditional IRA when withdrawing the funds at retirement since they will most likely be in a lower tax bracket (withdrawals from a traditional IRA are taxed at ordinary income tax rates).
Converting a Traditional IRA to a Roth IRA
Individuals also have the option of converting an already-established traditional IRA to a Roth IRA. Initiate the conversion only if it fits your long-term plan and goals.
The IRS will collect federal tax on a Roth IRA conversion with the rest of your income taxes due on the return you file for the year of the conversion. The ordinary income generated by a Roth IRA conversion generally can be offset by losses and deductions reported on the same tax return. Consider avoiding using the funds that are being converted from your Roth to pay the tax on the conversion. By doing so, you will have less left in the account to potentially grow tax free and, if you are under 59½, you’ll also incur a 10% penalty on the amount you don’t convert to the Roth IRA. Also, keep in mind you may be required to make estimated tax payments in the year of the conversion, before you file your annual return.
The Roth 401(k)
Roth 401(k)s allow employers to add a Roth IRA- type feature to a 401(k) plan. This feature lets employees designate all or a portion of their 401(k) contributions as “designated Roth contributions.” These contributions are held in a separate account from the employee’s traditional 401(k) and handled similarly to a Roth IRA, i.e., contributions would not be tax deductible, and distributions are generally tax free. Note that only employee elective deferrals may be added to the Roth 401(k)—employer matches and forfeitures cannot.
How does the Roth 401(k) differ from the Roth IRA? For one thing, contribution limits are higher. They are comparable to traditional 401(k) contribution limits ($22,500 in 2023, $30,000 if age 50 or older),1 and there is no adjusted gross income limitation to phase out the employee’s ability to contribute to a Roth 401(k). Similar to a regular 401(k), a Roth 401(k) is subject to RMDs.
If an individual wants to leave assets to his or her heirs, the Roth 401(k) falls short as an estate planning tool due to these RMD requirements. However, once you are eligible to take a distribution from your Roth 401(k), you can roll over the Roth 401(k) to a Roth IRA. Once those funds are transferred to the Roth IRA, there are no RMDs. So, if an employer offers a Roth 401(k), does it make more sense than a traditional 401(k)? Once again, the answer depends on your particular situation. Adding to the list of factors we outlined in the IRA discussion, expected work life, compensation level, current amount in a traditional 401(k) and expected rates of return should also be considered.
Consult With Your Advisor
At Mariner Wealth Advisors, we’ll work with you to evaluate which types of retirement accounts are appropriate for you, and we’ll create a wealth plan that includes a tax-efficient retirement savings strategy.
*Inherited IRAs are subject to different rules. Check with your financial advisor.
This article is provided for informational and educational purposes only and does not consider any individual personal, financial, legal, or tax considerations. The information contained herein is not intended to be personal legal, investment, or tax advice or a solicitation to engage in a particular investment or financial strategy. Nothing herein should be relied upon as such.
All expressions of opinion are subject to change without notice. Data contained herein is obtained from what we believe are reliable sources. However, the accuracy, completeness and reliability cannot be guaranteed.
Before initiating any IRA Rollover, Roth IRA Conversion or any financial related strategy please consult with a financial or tax professional regarding your personal situation. The strategies referenced here may not be suitable for everyone. Please ensure you consider all your available options, including applicable fees, taxes and features before making any financial related decision. Investing involves risk and the potential to lose principal.
If you convert a Traditional IRA to a Roth IRA, the amount of the conversion will be treated as a distribution for income tax purposes and is includible in your gross income (excluding any nondeductible contributions). If you are required to take a required minimum distribution (RMD) for the year, you must remove your RMD before converting to a Roth IRA.
A distribution from a Roth IRA is tax free and penalty free, provided the five-year aging requirement has been satisfied and one of the following conditions is met: age 59½, disability, qualified first-time home purchase or death.
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