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Traditional vs Roth IRA: What’s Best for You?

When it comes to saving and investing for the future, there are a lot of decisions to make. Everyone wants to do what’s best for themselves and their family, but the volume of information out there can be daunting.

Perhaps one of the most common questions that comes up regarding investing, saving, and taxes is the traditional vs Roth IRA dilemma. Both are excellent vehicles for saving for the future, but there are some unique differences than can make choosing one or the other confusing for some investors.

In this blog, we’ll draw on our 40+ years of experience helping individuals and families to clear up some information about traditional and Roth IRAs so that you can make the decision that’s best for you.

 

Life, Death, and Taxes

 

Tax treatment is the biggest difference between a traditional IRA and a Roth IRA. How the taxes are handled on money going in and how the money is treated when it comes out is much different between the two investment account types. That tax consideration will be one of the main reasons a person would choose one account over the other.

A traditional IRA uses pre-tax income when making contributions. This means that people who are setting aside money in their traditional IRA may be able to save on income taxes in the current year, whether that’s a full deduction or a partial one.

With a Roth IRA, the money going in is after-tax dollars. This means that the contributor has already paid their income taxes. While the contribution won’t offer them any tax savings in the current year, they will be able to withdraw their contributions without paying income tax in the future.

When looking at the tax treatment of contributions between the two types of accounts, investors should consider their current income level and their expected retirement income. If they believe that they will be in a lower tax bracket in retirement, then saving on tax now and paying later through a traditional IRA may be best.

 

How Flexible is the Investment?

 

Flexibility is always a nice feature when it comes to money. Many financial experts recommend having emergency savings on hand to pay for unexpected expenses. However, less than half of Americans have enough money saved to pay for a $1,000 expense.

In terms of flexibility, a Roth IRA provides simple withdrawals, as the contributions can be taken tax-free. This means that someone could use a Roth IRA to save for long-term goals such as retirement, as well as short-term goals like building an emergency fund or saving for a new vehicle.

If someone needs more than what they have contributed, they could also withdraw their earnings and growth, but this would be considered taxable income.

A traditional IRA is much less flexible when it comes to withdrawals. Yes, investors could choose to withdraw early, but they would then be on the hook for the deferred taxes from when they made the contribution, as well as a 10% penalty from the IRS. If someone is still working and chooses to withdraw early from their traditional IRA, they could be in for a serious shock at tax time.

With that in mind, a traditional IRA is better suited for long-term investors planning to save for retirement rather than those who are looking to set aside funds that may need to be accessed early.

 

Consider Eligibility Criteria

 

Sometimes, the decision for an investor may be made for them simply by how much they earn. A Roth IRA has income limits and those that earn more than the upper threshold cannot contribute at all. Some income earners may only be able to contribute a portion of the maximum contribution and look elsewhere if they wish to save more.

The limits are adjusted each year. For example, someone earning more than $140,000 as an individual in 2021 could not contribute to a Roth IRA. In 2022, that upper limit was increased to $144,000. The figures are also different for married couples filing jointly.

In the case of a high-income earner, a Roth IRA may not even be an option. However, there is an IRS-approved strategy called a backdoor Roth IRA which has investors contribute non-deductible contributions to a traditional IRA and then convert to a Roth IRA later.

 

Buying a Home?

 

For those saving to buy a home, a Roth IRA offers a unique advantage that may make it the preferred savings vehicle. In addition to contributions, first time homebuyers can also withdraw $10,000 of income and earnings from their Roth IRA for their down payment. This can help make qualifying for a home purchase easier, lower mortgage payments, and bring the dream of home ownership a little closer for many.

 

So, What’s the Final Answer?

 

There is no clear right or wrong answer when it comes to choosing between a traditional IRA or a Roth IRA. The choice will ultimately hinge on one’s unique life stage and goals. Many people use both accounts for their contributions to take advantage of the unique features offered by each.

When making the choice, there are a lot of considerations and it’s important to have trusted experts in your corner. If you’re debating how to move forward with saving and investing, we’re here to help guide your decision. With 40+ years of experience providing professional and honest advice, Cukierski & Associates continues to be a resource for individuals and families at all stages in life.

To learn more, contact us today.

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