Choosing between IRA accounts can be challenging because both have great benefits. You can’t go wrong with either option because of their tax breaks, but it mostly comes down to when you want to reap the benefits of the account.
Here are two things to consider when choosing between IRAs.
1. Your current vs. expected tax bracket
When considering a Roth IRA or a traditional IRA, it’s mostly about your current tax bracket and where you expect your tax bracket to be in retirement. With a Roth IRA, you contribute after-tax money and receive your tax break by having your money grow and compound with tax-free withdrawals in retirement. With a traditional IRA, you get your tax benefit up front. Although you technically contribute after-tax money to a traditional IRA, there is a chance that your contributions may be deductible.
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Starting in 2022, the maximum amount you can contribute to an IRA, both Roth and traditional, is $6,000 ($7,000 if you’re age 50 or older). The amount you can deduct from your traditional IRA contributions depends on your income and whether you’re covered by an employer’s retirement plan.
If you are covered by a retirement plan at work, here is the amount of your contributions you can deduct:
|Tax filing status||Entry||Allowable Deduction|
|Unique||$68,000 or less||Total amount|
|Unique||$60,801 to $77,999||partial amount|
|Unique||$78,000 or more||No deduction allowed|
|Married Filing Jointly||$109,000 or less||Total amount|
|Married Filing Jointly||$109,001 to $128,999||partial amount|
|Married Filing Jointly||$129,000 or more||No deduction allowed|
|Married Filing Separately||Less than $10,000||partial amount|
|Married Filing Separately||$10,000 or more||No deduction allowed|
If you’re single and not covered by a work retirement plan, or married filing jointly (with a spouse not covered by a work plan), you can earn any amount and take a full deduction.
If you are married and your spouse is covered by a work plan, here are the income and allowable deductions:
|Tax filing status||Entry||Allowable Deduction|
|Married Filing Jointly (with a spouse filing it is covered by a work plan)||$204,000 or less||Total amount|
|Married Filing Jointly (with a spouse filing it is covered by a work plan)||$204,001 to $213,999||partial amount|
|Married Filing Jointly (with a spouse filing it is covered by a work plan)||$214,000 or more||No deduction allowed|
|Married filing separately (with a spouse who it is covered by a work plan)||Less than $10,000||partial amount|
|Married filing separately (with a spouse who it is covered by a work plan)||$10,000 or more||No deduction allowed|
If you’re at the height of your career, it’s usually best to take tax relief now, when it’s most valuable. For example, if you’re in your peak earning years and your current tax bracket is probably the highest you’ll find yourself in, you should consider contributing to a traditional IRA now (taking the deduction if you’re eligible) and then paying taxes on it. income on your withdrawals during retirement, when your tax bracket is lower.
If you’re early in your career and this is likely to be the lowest tax bracket you’ll find yourself in, it makes more sense to pay taxes on money now rather than later, when your bracket is higher. You will never stop paying taxes; Uncle Sam is not having that. But you they can be strategic about when to pay, so you can pay as little as possible.
2. If you think you will need the funds when you retire
Unfortunately, traditional IRAs have required minimum distributions (RMDs). No matter what happens, you must start receiving distributions before April of the year after you turn age 72. If you don’t take your RMD, the amount not withdrawn is subject to a 50% penalty, a costly mistake. However, Roth IRAs do not have RMDs; you can keep the funds in the account for as long as you like.
If you’ve managed to save enough for retirement in other accounts, like a 401(k), and decide you don’t need the funds in your Roth IRA, you can keep the assets there and give them more time to grow and compound. In fact, it’s not uncommon for people to do this and then pass the bill on to their children when they die. If you think you’ll be financially comfortable in retirement without needing your IRA funds, you may want to consider a Roth IRA because you don’t have an RMD.
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