I am often asked whether someone should contribute to their Roth or Traditional IRA. We’re going to look at how we go about this process in this week’s Inside Look at Building Toward Wealth.

Please note, the information contained here is for 2023. You are still able to make contributions for 2022 until April 18th. If you need help reviewing your eligibility for 2022 contributions, you can check our 2022 information here or you can reach out to me HERE.

Roth IRA

A Roth IRA is a retirement account where you contribute after-tax dollars, and the money grows tax-free. You can withdraw the money tax-free in retirement if you meet certain requirements.

Taxation: With a Roth IRA, you pay taxes on the money you contribute upfront, but you won’t owe any taxes on qualified withdrawals in retirement. This means that you don’t get an immediate tax deduction for your contributions, but you benefit from tax-free growth and withdrawals in the future.

Income limits: There are income limits for contributing to a Roth IRA. For 2023, if your modified adjusted gross income (MAGI) is $153,000 (single) or more or $228,000 (married filing jointly) or more, you can’t contribute to a Roth IRA directly. However, you may be able to do a backdoor Roth IRA.

Withdrawals: With a Roth IRA, you can withdraw your contributions at any time without penalty. However, if you withdraw earnings before age 59 ½ and have not met the 5-year holding requirement, you may owe taxes and a 10% penalty.

Required minimum distributions (RMDs): With a Roth IRA, you are not required to take RMDs during your lifetime. This makes it a good option for people who don’t need the money in retirement and want to leave it to their heirs.

Traditional IRA

A traditional IRA is a retirement account where you contribute pre-tax dollars, and the money grows tax deferred. You will owe taxes on withdrawals in retirement.

Taxation: With a traditional IRA, you get an immediate tax deduction for your contributions, but you will owe taxes on withdrawals in retirement. This assumes you meet the requirements we outline in Can I make A Deductible IRA Contribution. This means that you get a tax break now, but you’ll pay taxes on your contributions and earnings later.

Income limits: There are no income limits for contributing to a traditional IRA. However, if you or your spouse is covered by a retirement plan at work, your contribution may not be fully deductible.

Withdrawals: With a traditional IRA, you can start taking penalty-free withdrawals at age 59 1/2. However, you will owe taxes on the money you withdraw.

RMDs: With a traditional IRA, you are required to take RMDs starting at age 72. This means that you will have to start taking money out of your account even if you don’t need it.

Which one should you choose?

If you expect to be in a higher tax bracket in retirement, a Roth IRA may be a better option, as you will pay taxes on your contributions now when you are in a lower tax bracket. If you expect to be in a lower tax bracket in retirement, a traditional IRA may be a better option, as you will get a tax break now and pay taxes on your withdrawals when you are in a lower tax bracket.

Other factors to consider include your current income, your future retirement income, and your financial goals. It’s always a good idea to consult with a financial advisor or tax professional to determine which option is best for you.