Roth IRA or Traditional IRA?

When planning for your retirement it's important to select a retirement plan that aligns with your situation and future financial objectives. The Roth Individual Retirement Account (IRA) and the Traditional IRA are two retirement plans, with similar options commonly found in 401k plans. Differentiating between the two can be complex. Understanding their distinctions can assist you in making a well-informed investment choice.

The main contrast, between these IRAs lies in the timing of their tax advantages. In a Traditional IRA, contributions are made using tax funds providing an upfront tax benefit. Conversely a Roth IRA is funded with after tax money, yet qualified distributions in retirement are tax free.

Your decision on whether to opt for a Roth IRA or a Traditional IRA should primarily depend on your tax bracket. Anticipated financial status during retirement. If you foresee being in a higher tax bracket post-retirement than you're presently a Roth IRA might be more suitable as it offers tax withdrawals. On the hand if you predict being, in a tax bracket when retired investing in a Traditional IRA could allow you to take advantage of reduced tax rates on future withdrawals.

However, there is more to it than this. If you only have pre-tax dollars in your retirement accounts, not only will you be subject to significant RMD's (required minimum distributions) causing a higher-than-expected tax situation, but depending on future tax rates, you could be in a higher bracket than you ever expected. Having a tax diversified portfolio gives you more options and protects you from the potential of higher taxes in the future. Furthermore, if you don't spend down the Roth in your lifetime, it transfers to your beneficiaries tax free as well!

Taxes are already set to go up in 2026 at the expiration of the Tax Cuts and Jobs Act.

Tax Cuts and Jobs Act

The expiration of the Tax Cuts and Jobs Act (TCJA) raises some points to think about. The TCJA, which was approved in 2017 reduced income tax rates, for individuals but these reductions are scheduled to end after 2025. If the current law is not extended or replaced many taxpayers could see an increase in their tax rates back up to pre-2017 rates. Therefore, now might be a time to make use of the tax rates by contributing to a Roth IRA. With today's tax rates you can pay taxes at a known rate now. Enjoy tax free withdrawals when you retire, possibly at a higher tax rate.

On the hand if you expect your income to decrease significantly after 2025 the potential rise in taxes may not affect you much. This makes the upfront tax deduction of an IRA more appealing.

Conclusion

Before making any decisions take into account your situation and retirement plans. Seek advice from a financial advisor if necessary. The choice between a Traditional or Roth IRA hinges on your circumstances such, as income level, future tax rates and retirement timeline. Make sure you carefully consider your choices for the future. Take the time to explore your options and seek advice from a professional to make sure you maximize your retirement savings.

About the author:

Paul Carriere CFP® provides fee-only financial planning and investment management services in Colorado Springs, Co. Carriere Financial Planning serves clients as a fiduciary and never earns a commission of any kind. Paul has over 9 years of experience as a financial advisor in Colorado Springs. 

* This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on for purposes of avoiding any Federal tax penalties. Individuals are encouraged to seek advice from their own tax or legal counsel. Individuals involved in the estate planning process should work with an estate planning team, including their own personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation by us of a specific investment or the purchase or sale of any securities.