What is the Difference between a Roth IRA and a Traditional IRA?

Most savers are aware that an Individual Retirement Account (IRA) is a great way to begin setting aside savings for retirement but are often unsure if a Traditional IRA or a Roth IRA, the two most common IRAs, makes more sense for them. Contributions to a Traditional IRA are tax‑deductible (subject to certain limitations) and withdrawals from the account are taxed as income during retirement. Contributions to a Roth IRA are not deductible, but withdrawals during retirement (including any investment growth) are not taxed. The choice between a Roth and a Traditional IRA ultimately comes down to three factors: your current income, what you expect your income to be in the future, and whether you have a retirement plan available to you at work.

Your current income can determine your eligibility as to which IRA you can contribute. A few considerations:

  • The IRS sets income limits each year that determine your eligibility to deduct the contribution to a Traditional IRA or even contribute to a Roth IRA. If you are above the income limits, the contribution to a Traditional IRA would be non-deductible. For Roth IRAs, once you are above the income limit you cannot contribute to this account.
    • In 2021, you can make the full contribution (and have it be deductible for taxes) to a Traditional IRA if your income is below $105,000 for married couples filing jointly. The deductibility of this contribution continues to phase out from $105,000 to $125,000.
    • In 2021, you can make the full contribution to a Roth IRA if your income is below $198,000 for married couples filing jointly. The ability to contribute to this type of IRA completely phases out once you have income of $208,000.
  • Your current income also impacts which type of IRA makes more sense for you. If you expect to be in a higher tax bracket when you are retired, the Roth IRA will provide for tax-free withdrawals (income) later in life. This is often the best choice for those early in your careers who expect your earning potential to increase as you advance in your employment.
  • Conversely, for those who are higher earners today, making a tax‑deductible contribution to a Traditional IRA could provide a greater benefit, as you will likely be in a lower tax bracket when retired.
  • If you have a retirement plan available to you at work (such as a 401(k) or 403(b) account) you may not be eligible to deduct a contribution to a Traditional IRA.

Fortunately, many employer plans now offer Traditional and Roth options as well. Contributions to a 401(k) or 403(b) account are not deductible on your tax return, but they are also not included in the taxable income you report to the IRS. Contributions to a Roth plan are calculated in your current taxable income, but future withdrawals will not be taxed. When deciding whether to take advantage of a 401(k) or 403(b) plan’s Traditional or Roth option, consider the same factors that would determine whether a Traditional or Roth IRA is better for your situation.

 

Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.

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