Last week our discussion centered on your Financial Checklist for the New Year and included making both your 2018 and 2019 contributions to either a Traditional IRA or Roth IRA as soon as you’re able…hopefully this month. If you’re ready to make that investment or at least set up a monthly auto-investment plan for one or the other, which strategy is best for you?
As a reminder, with a traditional IRA, you receive an income tax deduction for your contribution, annual earnings and growth are tax deferred, and withdrawals during retirement are taxed as ordinary income. At age 70½ you must begin taking Required Minimum Distributions (RMDs). With a Roth IRA, you do not receive a tax deduction for your contributions, annual earnings and growth are tax deferred, and withdrawals during retirement are tax free. With a Roth, RMDs are never required.
Basic rule-of-thumb: If you expect your income tax bracket during retirement to be equal to or higher than your current tax bracket, a Roth is generally your best choice.
Let’s get specific based on 2019 income tax rates:
Do a Roth if…
- Your taxable income is less than $78,950 for joint filers; $39,475 for single filers.
Do a Traditional IRA if…
- Your taxable income is more than $321,450 for joint filers; $160,725 for single filers.
For inbetweeners…
If your taxable income falls in-between the above numbers you fall in a gray area and the best choice depends on your individual facts. A good place to start is to think about what the ideal retirement financial plan might look like. We find that in far too many cases, people are focused on their immediate tax strategy without any thought to their retirement tax strategy. For example, I’ve seen a lot of doctors and lawyers arrive at retirement with very large traditional (fully taxable) retirement accounts and little else in other types of investments. They retire and now must draw on their retirement accounts for income, all of which is fully taxable as ordinary income. This provides virtually no opportunity for income tax planning.
The ideal retirement financial package would look something like: one-half in traditional IRAs and one half in a mix of personal investments and Roth IRAs. With this scenario, you can exercise a lot of control over your annual income taxes.
Best answer: If your company offers a matching retirement plan contribution, obviously you should invest enough to capture the match…free money is always a good investment. Beyond that, focus on building assets in both traditional retirement accounts and personal investments/Roth IRAs.