Financial Abundance

Is it better to contribute to a traditional, deductible IRA or to a Roth IRA?  As with most personal finance questions, the answer is “it depends.” Let’s look at some guidelines to help you decide.

With a traditional IRA, contributions can only be made if you are under 70½ years old and you and/or your spouse have earned income. The maximum contribution is the lesser of $5,000 ($6,000 if over age 50) or the total amount that you and/or your spouse earned.  If you have a qualified retirement plan, the full amount can only be contributed if your Modified Adjusted Gross Income (MAGI) is no more than $55,000 as a single tax payer or $89,000 as a joint filer.

With a Roth IRA, your Adjusted Gross Income (AGI) must be less than $105,000 as a single filer or $166,000 as a joint tax filer plus you and/or your spouse must have earned income.  Like a traditional IRA, the maximum contribution is the lesser of $5,000 ($6,000 if you are over age 50) or the total amount that you and/or your spouse earned. If deductible IRA contributions are made, the amount that can be contributed to a Roth IRA is further reduced by the amount contributed to a deductible IRA.

The decision on which IRA to use is sometimes obvious:

1. A single filer with an AGI over $105,000 or a joint filer with an AGI over $166,000 who is not covered by a retirement plan can only fund an IRA.
2. If covered by a company retirement plan with a MAGI of over $89,000 but less than $166,000 as a joint filer or over $55,000 but less than $105,000 as a single filer, only a Roth IRA can be fully funded.
3. If you reach 70 ½ and have earned income, only a Roth IRA can be funded.
4. When saving to buy a first home, only with a Roth IRA can up to $10,000 of growth and income plus all contributions be withdrawn, tax and penalty free.

The following are more subtle advantages of Roth IRA plans:

1. For those under 40, the tax free growth combined with the tax free withdrawal of the funds (after age 59½), typically make the Roth IRA a better investment.
2. If funds are required before reaching age 59½, a Roth IRA allows the withdrawal of all contributions, with no taxes or penalty on this withdrawal.
3. For older individuals, a Roth IRA is an excellent way to pass funds to younger generations. The younger recipient may allow these funds to continue to grow tax free by withdrawing inherited Roth funds tax free over their lifetime

When none of the above apply, the decision of funding a Roth IRA or a traditional, deductible IRA must be made by analyzing your current tax bracket, what you believe will be your future (retirement years) tax bracket and whether you expect to consume the retirement funds or pass them to future generations.  If you need help making this decision, consult with your financial planner or tax adviser.