27 Jul I’m ready to invest. What kind of IRA should I choose?
Q. I am 49 years old and am considering getting an IRA. Which is best: traditional or Roth?
— Getting started
A. We’re glad to hear you’re in the position to start saving for retirement.
There are several issues to consider before you make your choice.
Traditional IRA contributions may be tax-deductible to you, said Michael Cocco, a certified financial planner with Beacon Wealth Partners in Nutley.
If your current marginal tax bracket is relatively high, the tax deduction you could receive could be meaningful to you to help reduce your tax bill at the end of the year, he said.
“It is important to note that if you (or your spouse) are covered under an employer sponsored plan at work, you may not be able to deduct your traditional IRA contributions for the current tax year,” he said. “However, if you are covered under a plan at work, you can still deduct the contributions if your Modified Adjusted Gross Income (MAGI) is less than $65,000 for single taxpayers or $104,000 for those married filing jointly.”
Contributions can be partially tax deductible if you make more but are subject to phase outs, Cocco said.
If you are not covered under a plan at work but your spouse is, you can still deduct your traditional IRA contribution in full if your combined MAGI is less than $196,000, he said, noting that partial deductions are available for higher incomes but are subject to phase outs.
“The caveat with making a tax deductible IRA contribution is that both your contributions and any earnings that result from these contributions would be subject to ordinary income at the time you withdraw these funds, and could be subject to an additional 10% premature tax penalty if withdrawn before the age of 59 ½,” Cocco said.
Roth IRA contributions are not tax deductible under any circumstances, but these accounts offer other benefits.
As long as you have the Roth IRA for more than five years and you are older than 59 ½, any withdrawals of contributions and earnings would be received tax-free, he said.
“Having a tax-free bucket of money to tap into in retirement can be very beneficial to help diversify how your various investments and accounts may be taxed,” he said. “Also, if you get into a situation where you need to access some of the funds from your Roth IRA, you can withdraw up to your contributions at any time without tax or penalty.”
Next, you need to consider your age and time horizon:
Typically, the longer a person has for a time horizon until they plan to use the funds, a Roth IRA may be more beneficial, Cocco said.
“If you plan to use the money soon, you may not be able to take advantage of the tax-free treatment of earnings that come with a Roth IRA,” he said. “But if you plan on not using the funds for a longer period of time, and as a 49-year-old, you may have 15-plus years until retirement, so you can have the opportunity to realize significant gains over time and receive those gains tax-free in the future.”
Next, you need to consider your investment risk preference.
Similar to the time horizon aspects of this decision, the more aggressive you would like to invest over time and the more potential gains you expect to earn, a Roth IRA would allow you to enjoy those gains tax-free, Cocco said. In a traditional IRA, you would be paying ordinary income tax on the gains as well.
Finally, consider what happens with Required Minimum Distribution (RMD) rules.
Cocco said when someone turns age 72, they must start taking RMDs from a traditional IRA in that calendar year, even if they do not need the money.
“However, if you plan to not touch this asset at that time, or plan to leave it to the next generation, a Roth IRA is not subject to these RMD rules,” he said. “That may be a consideration for someone to choose a Roth over a traditional IRA.”
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This story was originally published on July 27, 2020.
NJMoneyHelp.com presents certain general financial planning principles and advice, but should never be viewed as a substitute for obtaining advice from a personal professional advisor who understands your unique individual circumstances.