Roth IRA or Traditional IRA: Where Should I Invest My Retirement Funds?

By Hightower Westchester on October 9, 2018

As we are approaching year end, some of our clients are in the process of funding their respective retirement accounts.  The question that many clients ask is “which is better for me a Roth IRA or a traditional IRA?”.  The answer is it depends.  There are some major differences between these two popular retirement savings plans that need to be discussed and understood.

As a financial planner, looking at our clients’ financial picture holistically, we always try to educate them on the pros and cons of each retirement plan.  The initial dialogue almost always leads us to having a broader discussion with their tax advisor.  This is a collaborative effort as we need to understand the big picture, both of their assets and their overall tax situation, in order to provide feedback.  Funding retirement plans is a priority, but we want to make sure we have the correct plan in place to compliment the entire financial picture.

Taxes are a big part of the discussion as the plans have different types of benefits.  We try to paint a picture for our clients with the end in mind, that end being retirement.  Controlling or minimizing that tax risk is an important part of what we do.  In an ideal world we would like to have a scenario where a client has a Roth IRA, a traditional IRA, and an individual account.  This would allow us to draw money from each bucket in retirement to help minimize the tax implications.  Roth money comes out tax free, IRA money is taxed as ordinary income, and personal money is taxed as short or long-term capital gains.

Let’s take a look at the differences between a Roth IRA and a traditional IRA:

1. Income Limits: There are no income limits for people who contribute to a traditional IRA. The one thing to note is that some higher earners may not get a deduction on their contribution. For the Roth IRA, in 2018, the adjusted gross income phase-out range for taxpayers making contributions is $189,000 to $199,000 for married couples filing jointly.  For singles and heads of households, the income phase-out range is $120,000 to $135,000.
2. Age Limits: In a traditional IRA, once you turn age 70 1/2, you can’t make additional contributions. Whereas in a Roth IRA, you can make contributions regardless of your age as long as there is earned income.
3. Other plan participation: Your participation in a company retirement plan generally does not have an effect on your contribution to a Roth IRA or traditional IRA. What it may affect is your ability to deduct contributions based on income.
4. Money Withdrawals: This is one of the most important features. In a traditional IRA, once money is taken out, you pay ordinary income tax on these funds.  There is an additional 10% penalty if the funds are taken out before 59 1/2.

In a Roth IRA, you can take out withdrawals for any reason, penalty free.  The key here is that the withdrawals must be the amount contributed and not the appreciation or IRA conversions.  In order to take out the earnings, without paying taxes or penalties, you have to wait at least 5 years and you must be 59 1/2 or older.

5. Required Minimum Distributions (RMD): This is another major difference between the two. In a Roth IRA there are no minimum distributions at age 70 1/2 where as in a traditional IRA you must start taking out funds at age 70 1/2.

This is just an overview of the differences between the plans and you should have broader discussions with your advisors to come up with your customized investment strategy.  If you should decide to make decisions without consulting an advisor, please don’t overlook a crucial element of the plan which is choosing a beneficiary for each plan you’re enrolled in.

Roman Ciosek – Managing Director – HighTower Westchester

914.825.8633 – rciosek@hightoweradvisors.com