“If we command our wealth, we shall be rich and free. If our wealth commands us, we are poor indeed.” —Edmund Burke
“Don’t tell me where your priorities are. Show me where you spend your money and I’ll tell you what they are.” —James W. Frick
“Money is a guarantee that we may have what we want in the future. Though we need nothing at the moment it insures the possibility of satisfying a new desire when it arises.” —Aristotle
One of the questions that I get asked most often is should my contributions go to my traditional IRA or my Roth IRA. We’re going to take a look at which is probably going to make the most sense for you in this week’s Inside Look at BuildingTowards Wealth.
When considering the question of Roth vs Traditional IRA, the first question we should ask ourselves is whether or not you are eligible to contribute to a Roth or a traditional IRA? The Roth IRA has income phase-out limits.
Roth IRA contributions are never tax-deductible, and you must meet certain income requirements in order to make contributions. If you file taxes as a single person, your Modified Adjusted Gross Income (MAGI) must be under $139,000 for the tax year 2020 to contribute to a Roth IRA, and if you’re married and file jointly, your MAGI must be under 206,000 for the tax year 2020. The maximum total annual contribution for all your IRAs combined is $6,000 for under age 50 and $7,000 for those over age 50.
If you are ineligible to make a tax-deductible contribution to a traditional IRA and you cannot make a contribution to a ROTH IRA you could consider making a nondeductible traditional IRA contribution and then make a backdoor Roth IRA contribution.
What would make you ineligible for a tax-deductible contribution?
- If you have no retirement plan at work you can put money in (up to the annual contribution limit) and deduct the entire amount from your taxes. (If your spouse doesn’t work outside the home, he or she can also invest up to the federal limit and deduct the full amount.)
- If you do have a 401(k) or other retirement plan at work, your contribution is fully deductible only if your adjusted gross income (AGI) is less than $104,000 for a married couple filing jointly or $65,000 for an individual.
- -If you have a workplace retirement plan, the deduction for your traditional IRA contribution is phased out completely if your AGI is $124,000 or more (married couple filing jointly) or $75,000 or more (individual), or $10,000 for a married person filing separately.
If you are eligible to contribute to both the next question you need to ask yourself is, “Do you expect your future marginal tax rates to be higher than your current rates?” If the answer is no, you should consider making a contribution to your traditional IRA. The dollars you will contribute will be deductible now, at the higher rates. In the future, eligible distributions will be taxed when you are at presumably a lower tax bracket.
If you have any low income years, you could consider doing a partial Roth conversion to fill up the lower brackets.
If the answer is yes, do you expect your marginal tax rates to be higher than your current tax rates, then you should consider making a contribution to your Roth IRA. The dollars you contribute now will be taxable now, at the lower rates. In the future, eligible distributions will be tax-free when you are presumably in a higher tax bracket.
Your contribution limits for any one year are $6,000, $7,000 if you’re over the age of 50 in the year 2020. This is combined between the two types of IRA’s.
The next question is “Will you need retirement income from your IRAs?”
If the answer is no, consider making a contribution to your Roth IRA, which is not subject to RMDs.
If the answer is yes then consider the question “Do you want to maximize the contribution amount and can you afford to make the full contribution of $6,000 ($7,000 if age 50 or over)?”
If that answer is yes then consider making an after-tax contribution to your Roth IRA. The tax is paid with outside dollars on top of the contribution amount.
If that answer is no, consider making a partial contribution to your traditional IRA so you can receive a tax deduction now. Be mindful, you will have to pay taxes in the future upon distribution
Click on this link for an easy to follow flowchart on making the decision about whether or not a traditional or a Roth IRA is best for you.
Please feel free to reach out with any questions you may have.
Have an outstanding week!