When it comes to putting away money for retirement, a Roth could make more sense for you than a traditional IRA—or vice versa. Here's what to consider before making a decision.
TRADITIONAL AND ROTH IRAS both provide the potential for tax-beneficial growth that can give your retirement savings an extra boost. “The key difference between the two is the way your contributions and withdrawals are taxed,” says Debra Greenberg, director of Retirement and Personal Wealth Solutions at Bank of America.
Because all or a part of the money you contribute to a traditional IRA can be tax-deductible if your modified adjusted gross income is below a certain amount, using this type of IRA could help you lower your current tax bill. Check with the IRS.gov or your tax advisor to determine the amount of your deduction. You'll only have to pay taxes on the deductible portion of your contributions and any earnings when you begin to withdraw them in retirement.
Contributions to a Roth IRA, on the other hand, are not tax-deductible—but you see a benefit later on, because you won't have to pay federal taxes on qualified withdrawals.1 No matter which IRA you choose, you typically have until the tax return filing deadline to make your contribution for the previous tax year.
How Taxes Might Influence Your Decision
“Because of the tax differences, a traditional IRA is usually considered more advantageous for people who expect to be in a lower tax bracket in retirement,” says Greenberg, “but a Roth IRA might be better for you if you anticipate that your tax bracket will be higher when you retire.”
You're also probably better off with a Roth IRA if there's a chance you may need to tap into your IRA before you reach age 59½, because your contributions to a Roth IRA can be withdrawn at any time without taxes due. At the same time, any earnings on your contributions are only federally tax-free when a qualified withdrawal is taken, unless an exception applies. Also, you must hold your account for at least five years before you can tap those earnings without incurring a penalty. With a traditional IRA, if you withdraw funds before you reach age 59½, those withdrawals will be subject to a 10% additional early withdrawal tax, unless an exception applies.
No matter which IRA you choose, you typically have until the tax return filing deadline to make your contribution for the previous tax year.
What About Required Minimum Distributions?
Another big difference between the two is that with a traditional IRA, you must begin taking required minimum distributions (RMDs) once you reach your “required beginning date.”
The “required beginning date” for taking RMDs from a traditional IRA was recently increased from age 70½ to age 72 for people reaching 70½ after December 31, 2019. If you fall into this category, it gives you more time to let the investments in your traditional IRA grow tax-deferred.
However, if you reached age 70½ on or before December 31, 2019, your “required beginning date” is the date you reached age 70½ and you’ll be required to take an RMD for the 2019 tax year and every year after that.2 Generally, distributions from pre-tax IRA assets are taxed as regular income at the time of distribution.
“With a Roth IRA, there are no minimum withdrawal requirements for the original account owner, so if you're planning to use your IRA as another way to keep on investing for your heirs, a Roth IRA may be the better choice for you,” Greenberg notes. (Your heirs, however, will have to take distributions upon inheriting your Roth IRA.)3
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1 For a distribution from a Roth IRA to be federal (and possibly state) income tax-free, it must be qualified. A qualified distribution from your Roth IRA may be made after a five-year waiting period has been satisfied (this period begins January 1 of the tax year of your first Roth IRA contribution or Roth IRA conversion, if earlier) and you (i) are age 59½ or older, (ii) are disabled, (iii) qualify for a special purpose distribution such as the purchase of a first home (lifetime limit of $10,000), or (iv) are deceased. If you receive a non-qualified distribution from your Roth IRA, any earnings distributed generally will be subject to ordinary income tax, plus a 10% additional federal tax if received before age 59½ unless an exception applies.
2 You may defer your first RMD until April 1st in the year after you turn age 70½ or 72, as applicable, but then you’d be required to take two distributions in that year. There are also rules, regulations and limitations that have to be considered. For instance, you can only contribute to a Roth IRA for the 2019 tax year if your modified adjusted gross income is less than $137,000 (less than $203,000 for married couples filing jointly). For tax year 2020, you may contribute to a Roth IRA if your modified adjusted gross income is less than $139,000 (less than $206,000 for married couples filing jointly). Because of the nuances, it's best to check with your financial advisor and your tax specialist before making your decision. They can walk you through all the considerations that apply to your situation.
3 The rules governing post-death RMDs from traditional and Roth IRAs were modified under the recently enacted SECURE Act. Effective for beneficiaries of IRA owners whose deaths occur after December 31, 2019, beneficiaries may no longer stretch their RMDs over the course of their expected lifetime. Under the new law, your beneficiaries (other than spouses, children who have not reached the age of majority, individuals who are not more than 10 years younger than you, and individuals who are disabled or chronically ill) must withdraw the entire account balance—and pay income tax on those withdrawals—within 10 years.
Merrill, its affiliates, and financial advisors do not provide legal, tax, or accounting advice. You should consult your legal and/or tax advisors before making any financial decisions.