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Roth v.s. Traditional IRA - Which is Right for Me?

Writer's picture: Peter Mu, CFP® ChFC®  Peter Mu, CFP® ChFC®



The choice between a Traditional IRA and a Roth IRA depends on your individual circumstances, particularly your current tax situation and your expectations for future tax rates. Here are some factors to consider:


Traditional IRA:

  • Tax Deduction: Contributions may be tax-deductible in the year they are made, reducing your taxable income now.

  • Tax-Deferred Growth: Investments grow tax-deferred until you withdraw them in retirement.

  • Taxes on Withdrawal: Withdrawals are taxed as ordinary income during retirement.

  • Required Minimum Distributions (RMDs): You must start taking distributions at age 73.

Roth IRA:

  • No Immediate Tax Benefit: Contributions are made with after-tax dollars, so there is no tax deduction when you contribute.

  • Tax-Free Growth: Investments grow tax-free, and withdrawals are tax-free in retirement, provided certain conditions are met.

  • No RMDs: There are no required minimum distributions during your lifetime.

  • Income Limits: Eligibility to contribute to a Roth IRA is subject to income limits.

Considerations:

  1. Current vs. Future Tax Rates:

  • If you expect to be in a higher tax bracket in retirement, a Roth IRA may be beneficial since withdrawals are tax-free.

  • If you expect to be in a lower tax bracket in retirement, a Traditional IRA might be advantageous due to the immediate tax deduction.

  1. Need for Flexibility:

  • Roth IRAs offer more flexibility with no RMDs, allowing your investments to grow longer if you don’t need the funds immediately in retirement.

  1. Income Level:

  • High-income earners may not qualify for Roth IRA contributions and may need to consider a Traditional IRA or a backdoor Roth IRA conversion.

  1. Retirement Planning Strategy:

  • Many people choose to diversify their retirement savings by contributing to both Traditional and Roth IRAs to hedge against future tax rate uncertainties.


Common Sources of Retirement Income


If you consider income tax liability for the following retirement income sources it may help you formulate a picture of what your situation might be.


Social Security: partially taxable.

Employer-Sponsored Retirement Plans such as 401k, 403b: taxable except Roth.

Individual Retirement Accounts (IRAs): Taxable.

Personal Savings and Investments, including inheritance: Partially taxable.

Annuities: Partially taxable.

Life insurance with cash value: Not Taxable

Reverse Mortgage: Not Taxable


If majority of your income will be taxable adding Roth IRA will reduce your taxable income in retirement and be more beneficial.


On the other hand, there are many states that do not tax IRA distributions. Moving to those states will reduce your overall tax liability.


STATES THAT DON'T TAX RETIREMENT INCOME


  • Alaska

  • Florida

  • Nevada

  • South Dakota

  • Tennessee

  • Texas

  • Washington

  • Wyoming

  • Illinois

  • Iowa

  • Mississippi

  • Pennsylvania


There are many important factors to consider when it comes to reducing your tax liabilities in retirement. Speak with a Wealth Cairn financial coach today and start a conversation on your retirement today. Book a complimentary Zoom call here.

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