You may qualify to fund both a tax-deductible and Roth IRA. Alternatively, perhaps your employer offers the chance to fund either a tax-deductible or Roth 401(k). Which should you go for?
A key factor is whether you think your tax bracket in retirement will be higher or lower than it is today. If you expect your tax rate in retirement to be the same or higher, you should favor the Roth, giving up today’s tax deduction in return for tax-free growth.
Conversely, if you think you’ll be in a lower bracket, you should opt for the traditional IRA, taking a tax deduction at your high tax rate today while knowing you’ll pull those dollars out of your IRA at a lower tax rate once you’re retired. Many folks will be in this camp. The reason: You can deduct today’s retirement account contributions at your marginal tax rate, which could be 22% or higher, but in retirement your withdrawals might be your only income—and thus you’ll probably pay taxes at an average rate that’s well below 22%.
What if you’re unsure what your retirement tax rate will be? You might hedge your bets, dividing your money between traditional and Roth accounts.
While tax considerations often favor traditional IRAs, a Roth IRA might still be appealing, thanks to some unique advantages. Unlike with a traditional IRA, you can withdraw your regular annual contributions from a Roth IRA at any time for any reason. Just put $5,500 in a Roth? You can pull that money out tomorrow with no taxes or penalties owed.
Under current law, you also don’t have to take required minimum distributions from a Roth IRA once you turn age 70½. That means you can leave the account to continue growing tax-free, and you might even bequeath the account to your children or other beneficiaries. A Roth IRA can make a wonderful inheritance, giving your beneficiaries years of tax-free income using a strategy known as the “stretch IRA.” We discuss the stretch IRA further in the chapter on giving, including the risk that Congress might nix the strategy.
Like the idea of sidestepping required minimum distributions with a Roth IRA? If you fund a Roth 401(k), be sure to transfer it to a Roth IRA before you reach your 70s, because minimum distributions are required from a Roth 401(k). Avoiding required minimum distributions is also a reason to convert a traditional IRA to a Roth IRA.
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