The majority of taxpayers have until April 15th of the following year to make contributions into their Individual Retirement Accounts (IRAs). So while that gives you a fair amount of time to plan—right up until you file your tax return—there can still be a handful of questions to consider for your budget and goals.
When it comes to financial planning and IRA accounts, the key decision comes down to which type of IRA account you’ll be funding. Is a Traditional IRA the way to go? Or would you be better off with a Roth IRA? Let’s compare the pros and cons!
Roth IRA Pros and Cons
Understanding the differences between a Roth IRA and a Traditional IRA is crucial for making an informed decision. You want a strategy that aligns with your long-term financial objectives, and each type of account works in its own unique way.
The most significant advantage you’ll get with a Roth IRA is that your qualified withdrawals in retirement will be tax-free. That’s because your contributions are made with after-tax dollars. Even the earnings from your Roth IRA are included, meaning you won’t owe taxes on any of your qualified withdrawals (i.e., you’ve met the 5-year holding period and the account holder is at least 50 ½ years old, disabled, or deceased.) This feature is especially useful for individuals who expect to be in a higher tax bracket during retirement.
Moreover, unlike Traditional IRAs, Roth IRAs don’t come with required minimum distributions. Since you aren’t forced to withdraw money once you reach a certain age, you’ll have the option to leave your money in the account to continue growing tax-free.
Not only that, your Roth IRA contributions can be withdrawn at any time without penalties or taxes. This can give you a good amount of flexibility if you need to access your funds prior to retirement. These accounts also have perks for estate planning. Roth IRA beneficiaries can receive the funds tax-free, as well.
All that being said, Roth IRAs can still have some cons. For example, if you’re currently in a high tax bracket and want to reduce your taxable income, a Roth IRA may not make the most sense. Because contributions to Roth IRAs are made with after-tax dollars, you won’t get the tax deduction in the year you make your contributions. These accounts also have income limits for eligibility, which can be tricky for high earners. In 2024, individuals earning more than $161,000 are ineligible to contribute to a Roth IRA. For married joint filers, the cap is $240,000.
Traditional IRA Pros and Cons
Perhaps the most attractive feature with a Traditional IRA is that you get immediate tax benefits. Depending on your income level, contributions to Traditional IRAs are often tax-deductible, which can be great for taxpayers who are in a higher tax bracket now that they expect to be in retirement.
Traditional IRAs don’t have income limits for contributions, either. That makes them more accessible to high earners who may not be eligible for a Roth IRA. Along the way, any earnings made in your Traditional IRA account will remain tax-deferred. You won’t owe taxes until the money is actually withdrawn from the account.
One key point here, though, is that account holders can no longer make contributions into their Traditional IRA once they reach age 73. So while anyone with earned income can create a Traditional IRA, you have a time limit on contributing to the account. There will also be income limits to the amounts you can contribute with pre-tax dollars when you also have an employer retirement account set up. That’s why it’s often helpful to talk with an advisor to develop the best strategy for your retirement planning. There are a lot of scenarios to think through!
Guidance for the Road Ahead
When deciding between your options for IRA contributions, it’s important to have all the facts. With a Traditional IRA, your pre-tax contributions can grow more initially since you’re not paying taxes upfront. On the other hand, Roth IRA contributions are made with after-tax dollars, so while they might be smaller, the earnings can grow completely tax-free. Plus, Roth IRAs are generally more flexible when it comes to contributions and withdrawals.
There’s a lot to think about! That’s why it’s always a good idea to talk things over with a financial planner and your tax advisor. A team effort can help figure out what works best for you and your goals. Please remember that we’re here to help with any tax questions you have, giving you the guidance you need for the journey ahead. Feel free to send us a message if you’d like to schedule a time to talk. At NSO & Company, we’re here to help!