Roth IRA or Traditional IRA? How To Make an Intentional Choice

Roth IRA or Traditional IRA? How to Make an Intentional Choice

When I started my purpose-driven investment management firm, Mottet Wealth, the intentionality of investing was one of my core focus areas. Intentionality has everything to do with being present and aware of decisions we make. It’s about being direct and clear. Without clarity of thought, investing can seem like a maze. But with it, effective decisions can be made that work for you – not against you!

One of the best examples of how to use intentionality in investing was highlighted for me recently when I was talking to a new client about the pros and cons of opening an Individual Retirement Account (IRA). The question was clear: Should they go the Roth IRA route or the Traditional IRA route?

The client in question was daunted by this decision, almost paralyzed by having to make a choice when the implications were so far in the future. So, we sat down to get under the skin of this choice and unpack the best choice for them.

Roth IRA vs Traditional IRA: Let’s Talk Tax

When factoring in whether to go the Roth IRA or Traditional IRA route, the central question is whether you think your tax rate will be higher or lower in the future.

Yes, it’s a challenge to guess how you’ll be fixed in terms of tax when retirement comes knocking. After all, there is no way of knowing if you will be able to keep working – even part time – or if you might have to retire earlier than planned. The younger you are, the harder it is to project yourself into the future and make this call. The decision is made even harder because both options have tax-saving advantages:

  • Paying tax on future withdrawals but getting an immediate tax deduction in the here and now. That’s the Traditional IRA.
  • Looking forward to tax-free withdrawals in the future. This is when the Roth IRA steps up.

Based on tax implications alone there should already be indications around which IRA option is the best choice for you.

  • Best fit for a Roth IRA: If you anticipate you will be in a higher tax bracket when you retire – having built a tidy investment or property portfolio perhaps? – then a Roth IRA will mean that you can benefit from a delayed tax benefit.
  • Best fit for a Traditional IRA: If you expect that you’ll have a lower tax rate in retirement than you do currently, then a Traditional IRA may be the way to go. This approach would reduce your taxable income today but would mean that withdrawals on retirement are taxable – but at a lower rate.

Roth IRA vs Traditional IRA: The Other Differences

While tax is a notable consideration, there are other factors to this decision. Let’s delve into just a few questions I’m often asked:

  • Can I access funds before retirement? If you opt for a more flexible Roth IRA you can certainly withdraw funds without penalties – that is, if the funds have been in the Roth IRA for five years and the account holder is 59½ or older. However, early withdrawals from a Traditional IRA could incur penalties (usually at a rate of 10%) and there are also tax implications to consider.
  • Does the option involve required minimum distributions (RMDs)? While stipulated minimum withdrawals per year are not required for a Roth IRA, RMDs start at age 72 for Traditional IRA account holders. Your financial advisor can help you calculate the RMD you need to take based on your age and the balance in your Traditional IRA. Be aware that if you don’t take your RMDs you will be penalized about 50% of the amount due.
  • Are there age limits? Previously, it was only possible to open and make contributions to a Traditional IRA if you were younger than 70½. There were no such limits for Roth IRAs. This changed in 2019, bringing Traditional IRAs in line with Roth IRAs and removing any age restriction on opening and contributing to either option.

Are You Eligible for an IRA?

If you are earning an income you are eligible to contribute to an IRA. Since IRAs are usually used for personal pension savings, you could have an IRA as well as a 401(k) account with your employer – just to beef up your retirement nest egg.

Where it gets tricky from a financial management perspective is that the combined total you contribute to all your IRA retirement accounts over the year cannot exceed $6,000. In 2022, if you are 50 and older you can also make a catch-up contribution of $1,000 to boost this to $7,000 in total for the year.

There are also income limits to consider. If your Modified Adjusted Gross Income (MAGI) is less than $129,000 as a single tax filer then you can take full advantage and contribute up to the full limit into your Roth IRA. If you are married and filing jointly, this amount decreases to $204,000. The higher your household income, the less you can contribute to a Roth IRA – up to a limit of $144,000 for individuals and $214,000 for married couples filing jointly.

Of course, it is possible to reduce your household MAGI by contributing to a Traditional IRA, since contributions could be tax deductible based on your income limits. It’s in these areas of intentional planning around limits and options – and even incorporating both a Roth IRA and a Traditional IRA into your portfolio – that an investment advisor can bring true value to your retirement journey.

Navigating The IRA Ecosystem

One of the biggest thrills I get as an independent advisor is when I am able to work with a client to help achieve a secure retirement. We do this by making the optimum use of all the tools at their disposal. I am always amazed at the lightness the act of creating a solid plan for the future brings to my clients. With full confidence that their money is going to keep working for them, they are free to get down to the business of working, living and playing.

If you are planning for retirement, want to discuss IRA options or need help navigating the ins and outs of effectively managing your income in retirement, then get in touch for some intelligent and intentional investment advice.

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Add some financial confidence to your inbox with my monthly newsletter
Plus receive my free ebook: 5 Simple Ways to Bring the Purpose Back to Your Retirement Plan