To ROTH or Not TO ROTH, Is That YOUR Question?
By Allison Schmidt, Financial Advisor, CFP®, CPA
This question in the financial planning/investment world is about as easy to answer as someone who asks George up at Oasis Brewery, “Which do you recommend, the Scarab Red or the De Nile IPA?” Let’s be honest, neither would be a “bad” decision, but your friendly brewer and I need to know more about you to make the right recommendation. So, instead of deciding between a cold one with a hoppy finish or a smooth delicious amber, we’re deciding to either pay taxes today or when you withdraw the money.
Now that I have you thinking about which beer you’d like, let’s talk about what may drive you to drink…taxes. The primary difference between a Traditional IRA and a Roth IRA lies in whether you should pay taxes today and contribute to a Roth, or receive a tax deduction today and contribute to a Traditional, and then pay taxes when the cash is withdrawn.
- 1. Are you eligible for a Roth IRA?
- There are income limitations to qualify to be able to contribute to a Roth. For a single tax filer, for example, you must have modified adjusted gross income (AGI) less than $135,000 (phase-out starting at $120,000, per IRS guidelines). For married couples filing jointly you must have modified AGI of less than $199,000 (phase-out starting at $189,000).2. Will your tax rate be higher today or when you withdraw the money?Both options have very appealing tax breaks, it just depends on when you’re able to enjoy them. For a Traditional IRA, the contributions are tax deductible in the year they are contributed (think similar to your 401(k) at work). Whereas, a Roth IRA does not provide any tax break for contributions in the year contributed; however, the dollars grow tax free, so when you withdraw the appreciated amount, there is no tax owed.
So unless you’re Marty McFly and have joined us from 30 years in the future, you don’t know for sure the answer to that question. But don’t throw your hands up in defeat just yet, think about your current earned income, exemptions (do you have dependent children?), mortgage interest deduction, and other deductions that you claim today but likely won’t in retirement.3. Are you planning to pass the IRA onto your kids or grandkids?Another reason to use a Roth IRA is when passing assets on to future generations. If you’re currently retired and are putting together your estate plan, it may make sense to convert your current Traditional IRA or 401(k) to a Roth IRA and pay taxes on the assets today, as opposed to your heirs paying the tax once the account is inherited. Roth IRAs do not have required minimum distributions at age 70 ½ like Traditional IRAs, and also may make sense if you are currently in a lower tax bracket than your children.
These are just a couple of considerations for why you may choose one IRA over another. Every situation is different, so be sure to consult your tax and financial advisor about your specific situation before deciding which account would be most advantageous for you. Who knows, maybe even meet up at Oasis to discuss over a beer…I’d go with the De Nile.
DISCLOSURE: Unless certain criteria are met, Roth IRA owners must be 59½ or older and have held the IRA for five years before tax-free withdrawals are permitted. Converting a traditional IRA into a Roth IRA has tax implications. This material is being provided for information purposes only and is not a complete description, nor is it a recommendation. Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through HD Wealth Strategies, a registered investment advisor and separate entity from LPL Financial. The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. *Source: IRS.com