• Daniel Snitkovskiy

Traditional vs. Roth IRA, Which one should I choose?

Traditional IRA's are taxed when you withdraw (pre-tax), while Roth IRA's are taxed when you contribute (post-tax). Both of these are retirement investment accounts with a contribution limit of $6K a year and allow you to avoid capital gains taxes.

When comparing the different flavors of IRA's, there are 3 things to keep in mind (in order of importance):

1. Eligibility

As we saw in the income taxes article, the more you make, the fewer tax incentives you qualify for, and the number that's key for IRA eligibility is MAGI (numbers based on single/head of household tax filing status):

  • MAGI > $139K? You can't contribute anything to a Roth IRA (though you could contribute through the backdoor).

  • MAGI > $75K? You can't deduct Traditional IRA contributions (different limits if you're not covered by a workplace retirement plan).

Here's a short calculator to help you see quickly what your options are.

2. Current vs. Future Income

Assuming you are able to contribute $X to either kind of IRA, the next big thing to consider is your income level. Comparing what tax bracket you are going to be in at contribution time (CT) vs. withdrawal time (WT) will help you see which will save you the most in taxes. This is another big takeaway from the income tax article, in that the less money the government notices, the less you pay in taxes.

  • WT > CT? Roth IRA. Since you pay taxes at CT, you'll be essentially paying a discount.

  • CT > WT? Traditional IRA. The Traditional IRA is the opposite of the Roth, so you'd be discounted when you withdraw.

This is probably the fuzziest and most subtly complex area of comparison, so here's a more in-depth calculator to help you run the numbers.

3. Flexibility

With most retirement accounts, there are penalties for withdrawing money before you're 59.5. This is great to motivate sticking to your retirement goals, but if you're looking to retire early or have an extra cushion for emergencies, the Roth offers more flexibility for early withdrawal*.

*Note: You can withdraw contributions (not gains) from the Roth penalty-free.

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Disclaimer: The content on Young, Not Broke is for informational and educational purposes only and should not be construed as professional financial advice. Should you need such advice, consult a licensed financial or tax advisor.

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