Roth IRAs vs Traditional IRA

The Roth IRA and the Traditional IRA offer ways to save for retirement. Each offers different benefits. This article will show the important decision variables when choosing between the 2, as well as the impact of each on your current and future tax liabilities.


The Traditional IRA allows a person with earned income to take a tax deduction for dollars contributed, and the growth in the account is tax deferred. When distributions are taken from a Traditional IRA, they’re taxed as ordinary income. If you choose not to take distributions from an IRA after reaching 59½, the IRS will force distributions to be taken at age 72*. These are known as required minimum distributions and are based on the retiree’s life expectancy.


In order to do the deduction in 2020, an employee who’s covered by a workplace retirement plan (ex. 401(k)) must make less than $65,00 to $75,00 as an individual or $104,000 to $124,00 as a married couple. If one of the spouses is covered by an employer-sponsored plan, the income limits for the household are increased to $196,00 to $206,00, if no one in a household is covered by a plan, there isn’t an income limitation in order to deduct contributions to a Traditional IRA.


Traditional IRA contributions are subject to an income phase-out rule, which means if your income falls within the ranges above, your ability to take a tax deduction is phased out. For example, if you make less than $65,000 in 2020, you will receive a full deduction. If you make between $65,000 and $75,000, you’ll receive a phased out deduction. If you make more than $75,000, you won’t receive a deduction.


The 2020 contribution limit for a Traditional IRA is $6,000 with an extra $1,000 catch-up contribution for those 50 and over.


The other choice is a Roth IRA. It was established as an account into which after-tax dollars are invested. While the Roth IRA gives no tax deduction on the front end, the growth and eventual distribution is federal tax-free. Roth IRA allows a person to take out 100% of contributions at any time for any reason without taxes or penalties. It is only the growth which must wait until the age of 59 ½  to draw penalty-free. There’s a 5-year aging period, which means that a payment made from a Roth IRA is considered a qualified distribution if it’s made after a 5 year period, beginning with the first taxable year after a contribution to the Roth IRA occurs. There’s also exceptions for death or disability, and there’s a one-time $10,000 qualified distribution for first-time home buyers. 


If you make less than $124,000 for a single person or $196,000 for a married couple, you can contribute $6,000 per person and $7,000 for individuals aged 50 or older as of 2020.


For 2020, if an individual makes between $124,000 and $139,000 or $196,000 and $206,000 for a married couple, your allowable Roth contribution is phased out, and if you make over those incomes, you’re not eligible to contribute to a Roth IRA. 


Traditional IRA versus Roth IRA, the contrast is argued by many sides for various reasons. Most have focused on the difference between the 2 regarding taxation. It’s commonly suggested for people who would anticipate a higher rate of tax in the future, the Roth is the best option. For those, however, currently in their peak income earning years and expecting a lower tax rate in retirement, the traditional IRA has always been their best choice.


An important decision variable to keep in mind is income tax levels in the future. Most of the income generated by those in retirement is taxable. Up to 85% of one’s Social Security retirement benefit could be taxed depending on income. Pension income is taxed as well, but some states do not tax recipients of some pension income to draw retirees to their state. Tax-deductible contributions to 401(k)s and IRAs are going to be taxed in the year in which you take a distribution.


There are many pros and cons to each retirement account, but your decision should be based off of your own situation with attention paid to our age and where you are in your career.