If you are working on your taxes right now, you may be wondering which IRA you should contribute to before you submit your return. Roth IRA or traditional IRA? Which is better?
Following are three questions to answer before making that decision.
What was your Adjusted Gross Income for 2014?
If you are married and file a joint tax return with your spouse, and your Adjusted Gross Income (AGI) exceeds $191,000, you are not eligible to do a Roth IRA. In that case, a traditional IRA may be your only option.
For a chart of the income limitations on Roth IRAs, click here.
Do you or your spouse participate in a retirement plan at work?
If so, the tax deduction of your IRA contribution may be limited. If not, you may be able to deduct the entire contribution to your traditional IRA from your 2014 taxable income. Assuming your AGI is low enough to qualify you to do a Roth IRA and you also qualify to deduct any contributions you make to a traditional IRA, now you have a real choice.
For a handy chart of the income limitations for people who have a 401(k) or other retirement plan at work, click here.
This leads to the third question...
In the future, do you expect your tax bracket to be greater than, equal to, or less than what it is today?
If you expect your tax bracket in retirement to be equal to or greater than what it is now, then the Roth may be your best option.
If you are in a lower tax bracket today, 15% for example, but expect to be in a higher bracket such as 25% when you retire, then the Roth will offer you a greater benefit. Many experts, including nationally recognized IRA expert Ed Slott, agree and consider the Roth IRA to be the better of the two options.
Even if your tax bracket stays unchanged, Roth IRAs offer certain benefits. Roth IRAs grow tax-free, they have no required minimum distributions, and there is no tax due when your Roth IRA passes to your beneficiaries (although they will be required to take a minimum, albeit tax-free, distribution each year).
Another important benefit of Roth IRAs is that, since you fund them with after tax dollars, you can take out your principal at any time, for any reason without tax or penalty. I wouldn't suggest using Roth IRAs as an alternative to your short-term savings, but they do offer a level of liquidity that isn't available to traditional IRAs.
So which is better for you? Roth IRA or traditional IRA?
Everyone's situation is a little different, but unless you expect your tax bracket to drop in the future, I would say that for most people with a choice, the long-term benefits of the Roth IRA override the short-term tax deduction of the traditional IRA.