23 Dec Expand savings with a Roth or traditional IRA

Q. How can I decide if I should use a Roth IRA or a regular IRA? I have a 401(k) at my job — the regular kind, not the Roth kind.
— Saving more

A. We’re glad to hear you want to save even more than you already are.

The first thing you’ll need to do is determine your eligibility for contributions.

For a Roth IRA, the only requirement for contributing is having earned income, which includes salary, bonus, commissions, taxable fringe benefits and/or tips, said Matthew DeFelice, a certified financial planner with U.S. Financial Services in Fairfield.

“The fact that you participate in a qualified retirement plan has no bearing on your eligibility to make Roth IRA contributions,” DeFelice said. “So if you have the money, you can contribute to both your 401(k) plan at work and your own Roth IRA, up to $5,500 — plus a $1,000 catch-up contribution if you are 50 and over — by the time your tax return is due.”

However, DeFelice said, your contribution may be limited or disallowed if your Modified Adjusted Gross Income (MAGI) is too high.

If you’re married and file jointly, you can make a full contribution in 2015 if your MAGI is no more than $183,000. You can make a partial contribution if your MAGI is between $183,000 and $193,000, and no contribution if your MAGI is $193,000 or more.

If you’re single or head of household, you can make a full contribution if your MAGI is no more than $116,000, a partial contribution if your MAGI is between $116,000 and $131,000, and no contribution if your MAGI is $131,000 or more.

If you’re married filing separately, you can make a partial contribution if your MAGI is between zero and $10,000, and no contribution if your MAGI is $10,000 or more, DeFelice said.

For a traditional IRA, if you or your spouse earn taxable income and are under age 70 ½, you can contribute.

As with a Roth IRA, you can contribute up to $5,500, plus a $1,000 catch-up contribution if you are 50 and over, by April 15, DeFelice said.

However, whether your contributions are tax deductible depends on your income and whether you have access to a work-related retirement account.

DeFelice said in 2015, if you have no retirement plan at work and you’re younger than 70 ½, you can put money in and deduct the entire amount from your taxes.

“If you do have a 401(k) or other retirement plan at work, your contribution is fully deductible only if your adjusted gross income (AGI) is less than $98,000 for a married couple filing jointly or $61,000 for an individual,” he said.

If you have a workplace retirement plan, the deduction for your traditional IRA contribution is phased out completely if your AGI is $118,000 or more (married couple filing jointly) or $71,000 or more (individual), or $10,000 for a married person filing separately, he said.

And if you’re not covered by a workplace plan but your spouse is, DeFelice said, your contribution is fully deductible if your combined income is less than $183,000 and gets phased out at $193,000 or more.

So which is better? That depends.

A traditional IRA provides a tax break today because by contributing pre-tax dollars, you lower your taxable income for the year of the contribution, but when you take money out in retirement, it’s taxable income, said Brian Power, a certified financial planner with Gateway Advisory in Westfield.

A Roth IRA, in contrast, provides a tax break down the road.

“After-tax dollars go into the account now but when you take the money out in retirement, they’re tax free withdrawals,” Power said.

Power said the traditional IRA should be chosen if you are in a higher tax bracket now than you will be in retirement or once you stop working full-time, which is likely for most folks.

And a Roth IRA should be chosen if you are in a lower tax bracket now than you will be in retirement or once you stop working full-time, such as those with pensions and deferred-compensation or if tax rates continue to climb, he said.

“Since no one knows for sure if their tax bracket will be higher or lower in retirement, I like the idea of hedging your bets and contributing to both types of IRA accounts,” Power said. “This will also diversify someone’s retirement income since some of the retirement account withdrawals will be taxable (traditional IRA) and some will be tax-free (Roth IRA).”

DeFelice agrees that it’s a smart strategy to hedge your bets taxwise.

In the current economic climate, no one knows what the state of Social Security will be in 20 or 30 years, or how much the government will need to raise taxes in the aftermath of long-term historic low interest rates, so guessing what tax bracket you will be in down the road may be next to impossible – especially if you’ve got a long way to go until you retire, DeFelice said.

He notes that Roths also offer more access flexibility than traditional IRAs.

“You can take tax-free withdrawals of your contributions without incurring a penalty at any time, and tax-free withdrawals on the earnings after a five-year period, assuming you are at least 59 ½,” DeFelice said. “You do get an exception to that rule if you become disabled or are using the funds for a first time home purchase.”

One other benefit to the Roth IRA at the moment — though politicians are discussing changes to this — is that there are no mandatory Required Minimum Distributions (RMDs) that have to be made like in a traditional IRA starting at age 70 ½.

“Because of this, the Roth IRA becomes a very powerful estate planning tool,” Power said. “If the mandatory required distributions from the traditional IRA are sufficient to support your retirement lifestyle, the Roth IRA can be left untouched and left to children or grandchildren beneficiaries, income tax-free as well.”

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This story was first posted in December 2015.