Key TakeawaysA traditional IRA provides deductions for deposits, it grows tax-deferred, and withdrawn funds are fully taxable as ordinary income. A Roth IRA does not provide deductions for deposits, but your money grows tax-deferred.Income limits on IRAs could restrict which type of account you can use.For the individual investor, the question of Roth versus traditional IRA may hinge on your personal preference: A tax deduction today or tax-free income in the future.Diversification in IRAs should be based on what makes sense for you and your retirement goals.<\/p>\n
Christine Benz: Hi, I\u2019m Christine Benz for Morningstar. Roth IRAs and 401(k)s allow for tax-free withdrawals, which is a major selling point. But Baird\u2019s Director of Advanced Planning, Tim Steffen, argues that Roth contributions aren\u2019t always the right call. He\u2019s here to share some tips on decision-making.<\/p>\n
Tim, thank you so much for being here.<\/p>\n
Tim Steffen: Great to be here, Christine.<\/p>\n
How Are Roth IRAs and Traditional IRAs Different?<\/p>\n
Benz: It\u2019s great to have you. Let\u2019s start with a bit of stage-setting to discuss the tax treatment of traditional tax-deferred and Roth accounts. How are they different?<\/p>\n
Steffen: Yeah, they\u2019re kind of mirror images of each other. A traditional account that\u2019s pretty basic in most cases, you get a deduction for whatever you put into it. It grows on a tax-deferred basis, and when the time comes to take the money out, it\u2019s going to be fully taxable as ordinary income.<\/p>\n
Roth works the opposite. There\u2019s no deduction for putting anything in there, so it\u2019s considered an aftertax contribution, but once it goes in there, it grows tax-deferred. If you meet some pretty basic rules, when it comes out, it\u2019s fully tax-free. There are some other differences in terms of required minimum distribution rules and what happens to beneficiaries of inherited accounts.<\/p>\n
At its essence, it\u2019s about deductible contributions going in and taxable income coming out, compared with nondeductible contributions versus tax-free income coming out. Which one\u2019s more important to you?<\/p>\n
Read more: IRA Favorites for Your Retirement Saving Plan<\/a>How Do Income Limits Affect Your IRA Options?<\/p>\n Benz: OK. I want to delve into that in a second, but first, with IRAs, income limits come into play, and it seems like your decision might be made for you in a way, if you\u2019re a higher-income earner, that your only option might be to do a Roth account or maybe even a backdoor Roth account<\/a>. Can you discuss that?<\/p>\n Steffen: From a traditional account standpoint, an IRA, the question is, can I deduct what I\u2019m putting in there? On an IRA side, there\u2019s a variety of rules that come into play, but generally, as your income exceeds certain thresholds, you lose the ability to deduct your contribution, and the money goes in on what we call an aftertax basis. There\u2019s exceptions to that for people who don\u2019t have an employer plan and that kind of thing, but generally that\u2019s the rule.<\/p>\n On the Roth side, Roth contributions are only available for people with income up to a threshold. For married couples this year, $242,000 is the threshold where you start to lose the ability to contribute to a Roth. As your income gets much higher, you not only can\u2019t do a Roth, you also can\u2019t do a deductible IRA; you\u2019re really kind of locked into one method, and that\u2019s the nondeductible IRA.<\/p>\n There\u2019s a band of income that\u2019s a little lower than that where the Roth contribution makes sense. As you get to lower levels of income, you\u2019ve got options. You can do the deductible traditional, or you can do the Roth. You\u2019re able to do both. You\u2019ve just got to decide which one makes more sense. That\u2019s the IRA side.<\/p>\n The employer plan side? Much different, totally wide open. Anybody\u2019s able to do a deductible or Roth as long as the plan offers it. It\u2019s a much, much bigger decision on the employer plan side than on the IRA side, frankly.<\/p>\n Key Things to Consider When Deciding on Roth vs. Traditional IRA Contributions<\/p>\n Benz: OK. As you just said, Tim, investors are apt to have more discretion over the Roth versus traditional decision because their income doesn\u2019t come into play. Can you discuss the key things?<\/p>\n Say I\u2019m a 401(k) or other company retirement plan participant. What should I be thinking about when I\u2019m confronted with that decision about whether I want my contributions to go in on a traditional tax-deferred basis or whether I want to make Roth contributions?<\/p>\n Steffen: Yeah. While on the IRA side, as you said before, your decisions are kind of locked in for you based on your income level with employer plans, 401(k), 403(b), you\u2019ve got total flexibility as long as the plan allows a Roth option, which most of them do these days. It kind of comes down to this issue of what\u2019s more important to you, having a tax deduction today or having tax-free income in the future.<\/p>\n The deduction today comes from putting money into the traditional account, and that would be: You\u2019re putting money in, you get a deduction for it, but when it comes out later, it\u2019s going to be fully taxable. Again, with the Roth, no deduction for the contribution today, but all the growth and everything that comes out of it in the future is going to be fully tax-free. That\u2019s going to be your primary decision.<\/p>\n As we said earlier, there are other things to think about, RMD rules, beneficiary rules, et cetera, but that deduction today versus tax-free income in the future, that\u2019s the big one.<\/p>\n Read more: Morningstar\u2019s Tax-Planning and IRA Resources for 2026<\/a>Tax Rates and IRAs, Now and in the Future<\/p>\n Benz: People have likely heard that to make that decision, it depends on evaluating your tax rate today and trying to hop into the future machine and figure out what it will be in the future. If there are many years from retirement, that can be really hard to get your arms around what sort of tax rate you\u2019ll be paying.<\/p>\n Do you have any guidance for people?<\/p>\n Steffen: Yeah, let\u2019s be honest, we don\u2019t know what the tax rates could be next year, or five years, or 10, 20, or 30 years. They can change at any time. What we try to tell people is, first of all, if you look historically, rates really don\u2019t change that much. It\u2019s not the laws that change. They do, but rates kind of stay within a band, deductions change, credits change, that all kind of work together to keep people at, as long as your income stays the same, kind of a consistent tax rate in many cases, or reasonably close.<\/p>\n What changes is your income level. Rather than focusing on what you think tax rates might be in the future, we tell people, \u201cFocus on your income level.\u201d If you\u2019re at peak earning years right now and you know that at some point you\u2019re going to retire and your income\u2019s going to fall off, while we don\u2019t know for certain, it\u2019s very likely you\u2019re going to be at a lower tax rate when that happens just because you have less income or the nature of your income has changed from wages to dividends and capital gains, which are taxed much differently.<\/p>\n Again, yes, generally you want to do a Roth contribution when your tax rate is lower and a traditional when it\u2019s higher, but you don\u2019t always know what the rates are going to be. Think about: Where am I at on an income basis? Am I at a low income level or a high income level, and what\u2019s going to happen when it changes, and how might I change my saving strategy then?<\/p>\n When Is a Roth IRA the Better Choice?<\/p>\n Benz: Yeah, that\u2019s helpful guidance. What do you think of the tax diversification argument that if you\u2019ve been saving for retirement primarily with traditional tax-deferred contributions, accounts, and that\u2019s the case for a lot of baby boomers or Gen Xers, it could make sense to prioritize Roth for these future contributions. Do you agree with that line of thinking?<\/p>\n Read more: An IRA Playbook to Build Wealth<\/a><\/p>\n Steffen: Kind of. Roth accounts have been around for about 30 years or so now. We\u2019re coming up on the 30th anniversary of Roth accounts soon. Most people who are working have had the opportunity to do a Roth or a traditional. If you were somebody who\u2019s only got their dollars in traditional accounts, I wouldn\u2019t say, \u201cOh, you should start putting everything in Roth just so you\u2019ve got Roth and traditional. You\u2019ve got to split.\u201d If it would\u2019ve been more right to do the Roth years ago, but that ship has sailed, that doesn\u2019t mean you should do it now. If you missed the opportunity to do it when it was right back then, don\u2019t compound that by doing it now when maybe it\u2019s not the right time.<\/p>\n Again, if you\u2019re at your later working years, you\u2019re in your 50s, approaching 60s maybe, and you\u2019re nearing retirement, you\u2019re probably at some of your highest earnings years. In those years, your traditional contribution may actually be a better option for you than the Roth. Unfortunately, that\u2019s when people really start thinking about Roths, and they tend to throw Roth money in when they\u2019re at those later working years.<\/p>\n Diversification is great. We want to have options when we get into retirement, but don\u2019t create Roth accounts simply because you don\u2019t have any, and therefore, you think you need them. Conversions may be another way to get there. That\u2019s something you can do after retirement. Again, when income falls, you\u2019ve got more flexibility on the tax side. From a contribution standpoint, don\u2019t just say, \u201cWell, I need Roth because I don\u2019t have Roth.\u201d You should do Roth because it makes sense from a tax and planning standpoint overall.<\/p>\n Benz: That makes sense. What are some instances when a person should favor the Roth contributions? I often think that it applies to maybe young people just starting out in their careers, who aren\u2019t yet earning much, and they have lower incomes. What\u2019s your take on that?<\/p>\n Steffen: Yeah, absolutely. I mean, the ideal Roth candidate is somebody who\u2019s at a lower income level, lower tax rate\u2014but again, we don\u2019t always know what tax rates are going to be\u2014lower income level than they might be later. People who are just starting in the workforce, or the early working years, high school kids with that summer job they get, they\u2019re great candidates for Roth. Why is that? Because their tax rate is so low, the value of a deduction is not that valuable. You\u2019re in a 10% or 12% rate, so that savings, that deductible contribution, isn\u2019t saving you a lot. As income goes up, maybe there comes a point when you start to shift your savings away from Roth into the traditional side.<\/p>\n When Should You Opt for a Traditional IRA?<\/p>\n Benz: OK. You mentioned that situation, the older worker\u2019s peak earnings years, that, even though they might want more Roth assets, actually taking advantage of the tax break and the year of contribution is often the better strategy. Are there any other situations that would point someone in the direction toward those traditional tax-deferred accounts and away from Roth?<\/p>\n Steffen: Again, it\u2019s a function of tax rates and timing. There\u2019s things you can do with IRAs. Perhaps you can always do conversions. So, if you really want Roth dollars, put it in the traditional IRA, get your deduction when you\u2019re at a high rate. When you retire, and you\u2019re in that, what we call the trough period, before RMDs start and your tax rate has fallen, then you do your conversions, then you get your money into the Roth when it costs you less to do so.<\/p>\n There comes a tipping point where a traditional IRA makes more sense than a Roth, or vice versa. There\u2019s always legislative changes. We\u2019ve seen things proposed that would say, cap the value of Roth accounts. That\u2019s usually a very high number. Most people aren\u2019t going to be concerned about that. If that was ever to come to fruition, then maybe we\u2019d steer more money into traditional, so you avoid some of those things. Generally, it comes down to that tax rate issue.<\/p>\n Benz: OK, Tim, this is a perennially hot topic, and we are so glad you\u2019re here to walk us through it today. Thank you so much for being here.<\/p>\n Steffen: Thanks, Christine.<\/p>\n Benz: I\u2019m Christine Benz from Morningstar. Thanks for tuning in.<\/p>\n Watch How to Build the Bond Core of Your Portfolio<\/a> for more from Christine Benz<\/a>. <\/p>\n","protected":false},"excerpt":{"rendered":"Key TakeawaysA traditional IRA provides deductions for deposits, it grows tax-deferred, and withdrawn funds are fully taxable as…\n","protected":false},"author":2,"featured_media":698201,"comment_status":"","ping_status":"","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[39],"tags":[28,147,530],"class_list":["post-698200","post","type-post","status-publish","format-standard","has-post-thumbnail","category-personal-finance","tag-business","tag-personal-finance","tag-personalfinance"],"_links":{"self":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts\/698200","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/users\/2"}],"replies":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/comments?post=698200"}],"version-history":[{"count":0,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/posts\/698200\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/media\/698201"}],"wp:attachment":[{"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/media?parent=698200"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/categories?post=698200"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.newsbeep.com\/us\/wp-json\/wp\/v2\/tags?post=698200"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}