I tend to favor the traditional IRA because contributions are deductible now, and my focus as a tax advisor is finding ways to reduce my client’s taxes this year. Later on though, when the money is eventually withdrawn, you have to pay taxes on all of your pre-tax contributions as well as the earnings that accumulated in the account over the years.
The Roth IRA on the other hand, does not allow for a deduction as contributions are made, but later on when the money is withdrawn, all of it comes out tax free including the investment earnings.
So you can see that both options have their advantages. Figuring out which option will work out best in the long run involves considering quite a number of factors including being able to predict what tax bracket you will likely be in after retirement.
For those who decide that the Roth IRA would be a better choice for them:
There are rules regarding who is eligible to contribute to either type of IRA. You have to have “earned income” to be eligible and whether or not you are covered by a retirement plan at work can affect your eligibility for either IRA option. For the Roth IRA there is also an income limitation that might come into play.
For 2017, if you are single, you can only make a partial Roth contribution once your AGI is $118,000 or more, and no contribution at all if your AGI is over $133,000. For a married couple only a partial contribution is allowed once your combined AGI reaches $186,000, and no contribution at all once your AGI reaches $196,000.
So what if you find yourself ineligible because your income is too high?
A way around the problem through the backdoor!
Traditional IRA accounts allow individuals to make non-deductible contributions regardless of one’s income. We don’t see many people choosing to do that but here’s a strategy where that option becomes quite useful.
You can make a non-deductible contribution to a new or existing traditional IRA account. Then a short while later, you can instruct the custodian of your IRA to convert that amount into a Roth IRA account. This strategy would work out quite nicely for those with very small traditional IRA accounts and have most or all of their retirement money sitting in a 401(k) plan at work. In this scenario there will be little to no tax on this conversion.
For those that do have traditional IRA accounts with substantial amounts in them, there may be an opportunity to transfer (or “hide”) those IRA accounts by rolling them into your employer’s plan before implementing this backdoor strategy.
I recommend that you consult with your tax advisor before actually making any moves.
The writer, Donald Karlewicz CPA CGMA is a partner with GKG CPA’s serving clients throughout the tri-state area. Contact DKarlewicz@GKGCPA.com for further information on this topic.