Is a Roth IRA or a Traditional IRA Better?

The best retirement savings account for you is highly dependent on your unique situation. Certain people may be better served by one option based on their income, age or when they prefer to pay taxes. If you’re not sure whether you should be saving money in a Roth IRA or a traditional IRA, consider scheduling a consultation with a retirement investment advisor at Fullerton Financial Planning.

The Differences Between a Roth IRA and a Traditional IRA

Both types of IRAs offer tax advantages. The main difference is when that advantage is gained. Traditional IRAs use “pre-tax” dollars, which means those dollars can be deducted from your income. Roth IRAs are funded with post-tax dollars.

When you withdraw funds from a Roth IRA, you don’t have to pay taxes on them – or the gains you’ve made on those funds over the years. Dollars dispersed from a traditional IRA are taxed like income.

For some savers, the choice comes down to their pre-retirement and post-retirement tax bracket. If you’re in a higher tax bracket now than you will be after you retire and start withdrawing from your retirement savings accounts, it may make sense to pay taxes when you’re in a lower income bracket.

On the other hand, young workers might be in a lower bracket today than they will be in 40 years when they retire. For them, it may make more sense to pay taxes on those dollars today and then withdraw them tax free once they retire.

How Are Traditional IRA Contributions Reported?

The IRS and state treasuries allow taxpayers to deduct their traditional IRA contributions from both federal and state tax returns. You can lower your adjusted gross income (AGI) by however much you deposit into your traditional IRA each year. 

This deduction may be another reason some taxpayers choose traditional IRAs. It’s possible the drop in your AGI may allow you to qualify for certain programs, like a student loan interest deduction or child tax credits for your family. It’s important to note your tax bracket is determined by your taxable income, not your AGI, so you cannot get into a lower tax bracket through traditional IRA deductions.

As with 401(k)s, there are some circumstances where you may be able to withdraw money from a traditional IRA early. However, any money you withdraw will be taxed as income, even if your early withdrawal justification exempts you from the 10 percent penalty.

Can You Deduct Roth IRA Contributions?

No, Roth IRA contributions are not tax deductible.

Are Roth IRAs Better for Low Income People?

You may want to speak with a financial advisor or tax planner before deciding if a Roth IRA is the better option for you, since each person’s financial situation is unique. However, Roth IRAs simply can’t be used by most high-income people due to the income restrictions.

As of 2022, single filers with an AGI over $144,000 or married couples filing jointly with an AGI over $214,000 are not eligible to invest in a Roth IRA.

There are a couple other unique features of Roth IRAs that make them desirable for some people. For example, there’s no minimum distribution requirement once the owner of the Roth IRA turns 59 ½. It can also be passed on to a beneficiary tax-free. The beneficiary must either take the money or roll it into their own IRA.

You can also withdraw money from a Roth IRA at any age (up to what you’ve contributed) without penalties or taxes. Savers have already paid taxes on every dollar they have contributed into their traditional IRA, so they’re never taxed a second time.

Which Type of IRA Should You Choose?

It’s a good idea to speak with a retirement investment advisor if you’re at a point in your life where you have the option of contributing to either a traditional IRA or a Roth IRA and you aren’t sure which to choose. Using a retirement investment advisor for investment guidance at Fullerton Financial Planning can help you weigh the pros and cons of each and may help you discover financial factors or tax implications you haven’t previously considered.

Call us today at (623) 974-0300 to speak with a financial advisor for more information.