Choosing Between a Traditional and Roth IRA

Sometimes, the decision of whether to contribute to a Traditional IRA or a Roth IRA is already made for you if you’re eligible to contribute to only one type of IRA. But if you are eligible to contribute to both, you will need to determine which one is best for you, and that may depend on your personal objectives.

Although retirement is the main reason for saving with an IRA, other reasons may factor into your decision. For example, accessibility—being able to use the money before retirement—may be important to you. Or maybe you are concerned about passing the assets to your beneficiaries tax free. Whatever your reasons for having an IRA, it’s important to realize what your objectives are before choosing an IRA. Consider the following key issues and how each may influence your decision.

• Access to tax- and penalty-free assets before and after retirement
• Anticipated tax rates while saving versus at retirement
• Anticipated rate of return on investments held within the IRA
• Number of years to save
• Number of years spent in retirement (the time period over which distributions will be taken)
• Effect of required minimum distribution rules
• Estate planning implications

The deciding factor for you may be whether you want—or can afford—to pay taxes now or later. A high tax rate now and a lower anticipated tax rate later favors the tax benefits associated with contributing to a Traditional IRA. Whereas, a low tax rate now and an anticipated higher tax rate later are factors that support contributing to a Roth IRA.

You also may want to consider the amount of time you have to save for retirement, as well as the anticipated rate of return on your IRA investments.

If estate planning is a concern, you may want to think about how each type of IRA will affect your beneficiaries. With one exception, beneficiaries of both IRAs are required, at some point, to take distributions. The exception is for Roth IRA spouse beneficiaries who treat the IRA as their own: they are never required to take distributions. In general, Roth IRA distributions to your beneficiaries are tax-free. But Traditional IRA distributions to your beneficiaries generally are taxable.

Assuming eligibility for both IRAs, common reasons for selecting one over the other are listed below.

Roth IRA

• Not eligible for a Traditional IRA deduction
• Anticipate having a lower tax rate while saving
• Anticipate having a higher tax rate during retirement
• Anticipate having higher earnings because there is more time to save (no age limit)
• Expect to receive a higher rate of return on contributions
• Want to avoid RMDs
• Want tax-free access to after-tax assets
• Concerned about income tax implications to beneficiaries
• Not concerned about tax law changes negatively affecting Roth IRAs

Traditional IRA

• Eligible for a deduction
• Anticipate having a higher tax rate while saving
• Anticipate having a lower tax rate during retirement
• Anticipate having lower earnings because there is less time to save (age limit)
• Expect to receive a lower rate of return on contributions
• Not concerned about RMDs, plan to withdraw more than minimum during retirement
• Not concerned about income tax consequences to beneficiaries
• Think tax law changes will negatively affect Roth IRAs

If you are finding it difficult to choose, consider contributing to both. Just know that the annual contribution limit applies to both types of IRAs in aggregate. For example, you cannot contribute more than $5,500 total for 2014 ($6,500 if you are age 50 or older) to both IRAs. You can divide the $5,500 between each IRA however you wish (e.g., $2,750 to the Traditional and $2,750 to the Roth).

Because several factors affect the decision of which IRA to go with, you may want to discuss it with a competent tax advisor.