Roth or Traditional IRAs: What's Best for Retirees?

Thomas and Robert Fross for Forbes write: Individual Retirement Accounts are one of the most popular ways to save for retirement. The two main types of IRAs are Traditional and Roth. As Americans approach retirement, it’s common to ask: which IRA is right for me?

Briefly, Traditional IRAs allow you to make pre-tax contributions – which may be deductible on your federal taxes – that grow tax-deferred and then are taxed during your retirement at your future tax rate. Roth IRA contributions are made after tax, do not qualify as deductions, and grow tax-free. Once certain aging requirements are met, distributions from Roth IRAs are not federally taxed.

Thomas: For retirees who expect their tax bracket to be lower during retirement, a Traditional IRA may be a better choice if they are still working. This way, they can make pre-tax contributions to a Traditional, potentially qualify for the deduction, and then pay taxes on distributions at their lower retirement tax rate.

Robert: Agreed. Clients in this scenario should also consider whether they are eligible to contribute to a Roth IRA. If their income exceeds a certain limit, they may not be eligible to contribute to a Roth that year.

If you are already retired, but still earning income, you need to consider the age limits placed on IRA contributions. Roth IRAs have no age limit on contributions (as long as you can show earned income,) but you cannot make a participant contribution to a Traditional IRA after your 70^th year.

Thomas: Many retirees maintain both types of IRAs. If you are eligible to contribute to both, you may split your contributions between your Roth and Traditional IRA. Under this strategy, it’s common to contribute the deductible amount to your Traditional IRA and the balance to your Roth; however, keep in mind that your total contribution still cannot exceed your limit for that tax year. It’s also important to consider the extra costs associated with maintaining multiple accounts.

Robert: Another strategy you may have heard of is a Roth conversion, which allows you to convert a Traditional IRA into a Roth by paying taxes on your contributions and earnings. This is frequently done during periods of market decline or when your tax bracket falls. The tax and financial implications of a conversion can be complex and it’s important to consult a financial advisor who can help you understand if a conversion may be right for your needs.

Thomas: For many taxpayers, the choice comes down to whether or not they are eligible to deduct their Traditional IRA contributions on their federal taxes. This depends on whether you are an active participant in an employer-sponsored retirement plan.  If not, then you may be able to deduct the full amount of your contribution. The rules regarding active participant status are tricky and it’s best to consult a tax advisor who can help you understand your personal situation.

Solutions:

As with most retirement topics, there’s no simple answer about which IRA is best for you. From a general tax perspective, a Roth may be a better choice if you do not expect your tax rate in retirement to be lower than your current rate; this will allow you to pay taxes on contributions now and receive tax-free distributions during retirement, when your taxes may be higher. On the other hand, if you expect that your tax rate will be lower in retirement, contributing to a Traditional IRA may be a smart option if you can receive a tax deduction now when your taxes are higher.

Ultimately, knowing which IRA suits your needs depends on a careful evaluation of the short-term and long-term benefits of each and an understanding of your current and future financial situation.

Securities and advisory services offered through SII Investments, Inc., member FINRA, SIPC and a Registered Investment Advisor.  Fross and Fross Wealth Management and SII Investments, Inc. are separate companies.  SII does not provide tax or legal advice.

You can visit the website of the authors, Fross and Fross Here.  You can Follow Fross and Fross on Twitter Here.