Traditional vs. Roth IRA, Which one should I choose?

What is a Traditional IRA?

An IRA stands for Individual Retirement Account. IRAs are held at banks and brokerages and allow you to invest in almost anything you can imagine. The benefit of having a Traditional IRA is that you can deduct your contributions on your tax return.

What is a Roth IRA?

A Roth IRA is very similar to a Traditional IRA. There is one exception: the money you contribute to a Roth IRA is taxed today (you cannot take a deduction on your tax return for contributions), but it is not taxed when you withdraw any money in the future. Therefore, all money you take out of an IRA, included gains on your investments, are not taxed in the future.

How much can I contribute to my IRA?

When you have an IRA, either Traditional or Roth, the most you can contribute is the lower of $5,500 or your taxable compensation for the year. If your taxable compensation is below $5,500, then you will be limited to the amount of your taxable income for the year. If you are over the age of 50, you are allowed to contribute $6,500 to your IRA.

How much can I deduct on my taxes for my IRA?

The amount you can deduct on your taxes depends on one condition: Do you or your spouse (if married filing jointly or separately) have a retirement plan at work? If the answer is no, they you are allowed to deduct the full amount of your contribution to your IRA. If the answer is yes then it can be a bit tricky.

I have a retirement plan at work, how much of my IRA contribution can I deduct?

The following chart is provided by the IRS to help determine how much of your IRA contribution you can deduct when you are provided with a retirement plan at work:

If Your Filing Status Is…

And Your Modified AGI Is…

Then You Can Take…

single or
head of household

$60,000 or less

a full deduction up to the amount of your contribution limit.

more than $60,000 but less than $70,000

a partial deduction.

$70,000 or more

no deduction.

married filing jointly orqualifying widow(er)

$96,000 or less

a full deduction up to the amount of your contribution limit.

 more than $96,000 but less than $116,000

  a partial deduction.

 $116,000 or more

 no deduction.

married filing separately

 less than $10,000

  a partial deduction .

 $10,000 or more

 no deduction.

If you file separately and did not live with your spouse at any time during the year, your IRA deduction is determined under the “single” filing status.
married filing jointly with a spouse who is covered by a plan at work

$181,000 or less

a full deduction up to the amount of your contribution limit.

more than $181,000 but less than $191,000

a partial deduction.

$191,000 or more

no deduction.

married filing separately with a spouse who is covered by a plan at work

 less than $10,000

 a partial deduction.

 $10,000 or more

 no deduction.

By utilizing this chart, take your filing status and adjusted gross income, and you can see if you are allowed to deduct the full amount, a partial amount, or no amount.

When can I withdraw money from my IRA?

The IRS allows you to withdraw from you IRA (Traditional and Roth) without any penalties after the age of 59 1/2. If you do withdraw from your IRA before this age you will be hit with a 10% penalty on top of the taxes you owe to the IRS. There are certain exceptions that will allow you to withdraw money penalty free before the age of 59 ½, which I will discuss below.

How can I withdraw money from my IRA without facing a penalty?

  1. You are over the age of 59 ½ you can withdraw money from your IRA penalty free. ‘
  2. You use withdrawals to pay higher education costs for your spouse, your children, or grandchildren.
  3. You can take up to $10,000 (or $20,000 if you are a couple) to buy, build or rebuild your first home.
  4. You use money from your IRA to pay for medical expenses in excess of 10% of your AGI which are not reimbursed during the taxable year.
  5. You become disable and can no longer be gainfully employed.
  6. You die and leave it to an heir.
  7. Roth IRA – You can withdraw your contributions but not your earnings (interest and dividends accumulated) from your Roth IRA at any point in time.

How long can I contribute to my IRA?

If you have a Traditional IRA, you are allowed to make contributions until the age of 70 ½ years old. If you have a Roth IRA, you are allowed to make contributions as long as you are alive.

Should I choose a Traditional IRA or a Roth IRA?

When deciding between a Traditional IRA and a Roth IRA, it could be tricky. With a Traditional IRA you can deduct your contributions in the current year that you make them. This is appealing if you want to lower to tax burden in the current year. You would also want to choose a Traditional IRA if you believe you will be in a lower tax bracket when you are older. That way you limit your tax payments to the lower future tax rate. In addition, you can contribute to a Traditional IRA at any time without income limitations. This differs from a Roth IRA which does not allow you to make contributions if you make over a certain income level.

With a Roth IRA, you cannot deduct your contributions in the current year that you make them. However, you will not be taxed on the money you take out of a Roth IRA in the future. This is appealing if you think you will be in the same or higher tax bracket when you are older. In addition, you can take out your principal contributions at any time without facing a penalty.

When it comes to choosing retirement accounts, take your time. Consult with your accountant or tax professional and make sure you pick the retirement account that best suits your needs.

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