What makes the most sense for you, staying with a regular individual retirement account or converting to a Roth IRA? This is not a simple question so there is no simple answer. But here are some things to ask yourself.
An individual retirement account is a great retirement savings tool for most individuals. Created by the federal government, IRAs are funded during your working years. In your retirement, IRAs may help supplement your Social Security benefits.
Your retirement savings begin with your annual IRA contribution. If you are under age 50, the current maximum annual contribution amount is $5,500, according to the Internal Revenue Service. For those 50 years and older, you can contribute an additional $1,000. So if you turn 50 this year, you are now eligible to contribute $6,500. The contribution amounts are adjusted for inflation each year by the federal government.
With a traditional IRA, you put money away and deduct it until you withdraw from the account in your retirement. You pay tax on withdrawals. Converting to a Roth IRA means you pay tax on your old account up from it, and from then on the account grows tax-free. Opening a Roth without converting is done with after-tax dollars, meaning you already paid the government.
If the Bush tax cuts expire at year-end without renewal, it may make sense to convert now, since taxes will go up.
To find out which of the two types, traditional or Roth, is best suited for you, here’s a quick way to weigh the pros and cons of each.
The advantages to a traditional deductible IRA:
Tax Deductible. Your contribution is deductible on your federal income tax return for the year in which you contribute.
Tax-Deferred Growth. Your contribution grows tax deferred until you withdraw the money. This means you do not pay any taxes while your money is growing.
Limitations to a traditional deductible IRA:
Adjusted gross income (AGI) limitations. The amount you can deduct is limited based on your AGI and, if you participate in your employer sponsored retirement plans. Your contribution may be fully deducted on your income taxes, partially deducted or not deductible at all.
10% Penalty. This is imposed to encourage IRA owners to keep their money in their retirement account until reaching age 59 ½. If you withdraw any of your money prior to then, you incur the 10% penalty on the amount you withdraw. There are some exceptions to the rule: educational expenses, first-time home purchase and certain medical expenses.
Advantages to a Roth IRA:
Avoid taxes in the future. Roth IRAs grow tax-free. Therefore, no taxes are due when you withdraw your money.
No Required Minimum Distributions (RMD). Roth IRAs do not require RMDs after age 70 ½, so your money can continue to grow with the potential for larger dollar amounts to leave to heirs.
Limitations to a Roth IRA:
AGI limitations. For high wage earners (2017 limits – single filing over $133,000 and married filing jointly over $194,000), Roth contributions are not allowed.
Disqualified distributions. The earnings in your Roth must remain in the account for five years (known as the five-year clock) and until you reach 59 ½ years. A 10% penalty is applied to earning distributions that do not meet these requirements.
Always consult a financial advisor or IRS publication 590 before you make your final IRA decision. Making the correct IRA choice now can benefit you down the road in your retirement.
Kimberly J. Howard,CFP
KJH Financial Services