They’re both taxed, so which is better, a Roth IRA or a Traditional IRA? Well, it depends.
I’m regularly asked whether I think a Traditional or Roth is the ‘better account’. My answer is, as with most financial planning questions, it depends. The general rule of thumb is to compare your tax rate when making contributions versus your anticipated tax rate when you intend to take distributions. If you’re a high earner now, it may make sense to decrease your taxable income and contribute to a Traditional 401(k) or IRA and reap the immediate tax savings. Alternatively, if you’re early on in your career or in the middle of a career switch and your income is lower, it may make sense to pay taxes now and allow your funds to compound tax-free in a Roth.
It’s worth noting that these decisions should be regularly reviewed. Even if your income remains the same, tax laws change and many contribution limits and phase-outs adjust annually.
Lastly, it’s important to keep in mind potential planning opportunities. A high earner who proficiently saves may find themselves with a substantial balance in their pre-tax retirement account. Traditional IRA’s and 401(k)s have Required Minimum Distributions (RMD) that begin at age 73 (75 if born on or after 1960). These RMDs could cause a retiree’s income to increase enough to bump them into a higher tax bracket and even potentially affect their Medicare Income-Related Monthly Adjustment Amount (IRMAA). Fortunately, given enough time to plan, a pre-retiree in this scenario could potentially benefit from strategic Roth conversions.
If you have any questions about retirement savings, our financial planning process or how we partner with your other trusted advisors (accountants, attorneys, etc.), please don’t hesitate to reach out. Call 203.730.5036 or email jdiaz@raymondjames.com
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