Retirement savings strategies: Traditional vs. Roth IRAs

Individual Retirement Accounts (IRAs) are long-term savings accounts you can use to make tax-advantaged investments that allow you to save for retirement. IRAs are typically used by self-employed individuals or people who do not have access to employer-offered pensions or workplace related accounts such as 401(k)s. There are a variety of IRAs available, but the two most common are Traditional and Roth. In this article, we’ll break down the differences between the two, how to choose, and explain why and when an IRA rollover may be beneficial. Both types of IRAs now allow contributions at any age, but it’s important to note that funds usually can’t be withdrawn before age 59 1/2, without incurring a 10% tax penalty.

Traditional IRAs

  • Tax implications: A traditional IRA allows for tax-deductible contributions. This means that the sum you contribute to your traditional IRA each year is dedicated from your annual income, providing an immediate tax benefit. Contributions and earnings grow tax-deferred until withdrawals are made during retirement, at which point they are subject to taxation at your income tax rate at that time.
  • Eligibility criteria: Anyone with income can contribute to an IRA, but the contribution and deductibility limits will vary based on whether you (or a spouse if you are married) have an employer-sponsored retirement plan through your workplace.
  • Withdrawal rules and penalties: Withdrawals from a traditional IRA are generally taxed as ordinary income, providing a potential tax advantage for retirees in lower tax brackets. Early withdrawals before age 59½ may incur taxes and a 10% early withdrawal penalty, with exceptions including qualified medical expenses and first-time home purchases.
  • Required minimum distributions: Traditional IRAs do require you to begin taking distributions from the account by April 1 after the year you turn 72.

Roth IRAs

  • Tax implications: A Roth IRA is a retirement account in which contributions are made with after-tax income, meaning you do not receive an immediate tax deduction. However, the unique advantage lies in the tax treatment of withdrawals. Qualified distributions, including earnings, are entirely tax-free if certain conditions are met.
  • Eligibility criteria: Roth IRA contributions are subject to income limitations, with eligibility phasing out for higher income earners. Like a traditional IRA contribution limits vary based on your filing status and adjusted gross income. Updated limits are available via the IRS.
  • Withdrawal rules and penalties: Contributions can be withdrawn at any time without tax or penalty, offering flexibility in emergencies. People who are over 59 1/2 who have had their account for 5 years or more are able to withdraw both contributions and earnings without penalty. However, withdrawal of earnings before age 59½ (or for folks who haven’t met the five year rule)may incur taxes and penalties unless specific exceptions apply, such as qualified education expenses or first-time home purchases.
  • Required minimum distributions: Roth IRAs do not require minimum distributions.

Determining the best fit

If you’re thinking about selecting a Roth or Traditional IRA you should consider the following factors:

  1. Current and future tax situation: Evaluate your current tax bracket and consider whether you anticipate being in a higher or lower tax bracket during retirement. A Roth IRA may be advantageous if you expect to be in a higher tax bracket in retirement, while a Traditional IRA may offer immediate tax benefits for those in higher tax brackets now, but who expect their income to be lower in retirement.
  2. Age and retirement timeline: Your age and the number of years until retirement can play an important role in determining the appropriate IRA. Younger individuals may benefit from the tax-free growth of a Roth IRA, while those nearing retirement may prefer the immediate tax deductions offered by a Traditional IRA.
  3. Income level: Income level impacts eligibility for deductible contributions to a Traditional IRA and contributions to a Roth IRA. Consider your current income and future earning potential when choosing the right IRA for your needs.
  4. Eligibility for deductible contributions: Participation in employer-sponsored retirement plans can affect the deductibility of contributions to a Traditional IRA. A financial professional can help you evaluate your eligibility for deductible contributions to maximize tax benefits.

Rollovers: When and how

In addition to choosing between Roth and Traditional IRAs, individuals may encounter situations where a rollover becomes necessary or beneficial. A rollover is a strategic transferring of funds from one retirement account to another, done in such a way that it does not trigger taxes or penalties. There are a few common scenarios when a rollover may be advantageous: 

  • Changing jobs: Individuals changing jobs may opt to rollover their employer-sponsored retirement plan, such as a 401(k), into an IRA to maintain control over their investments and potentially access a wider range of investment options.
  • Retirement: Upon retirement, you may consolidate multiple retirement accounts into a single IRA for easier management and potentially lower fees.
  • Inheritance: Since IRAs can be passed down, inheriting an IRA from a loved one presents an opportunity to roll over the inherited funds into your own IRA, allowing for continued tax-advantaged growth.

If you’re considering a rollover, you’ll want the guidance of an experienced financial professional who can guide you through some of the important considerations for successful rollovers. These include:

  • Direct rollover vs. 60-day rollover: Understand the difference between a direct rollover, where funds are transferred directly from one account to another, and a 60-day rollover, where funds are withdrawn and reinvested within 60 days to avoid taxes and penalties.
  • Tax implications and penalties: Be aware of the tax implications and potential penalties associated with rollovers, especially for 60-day rollovers, which require strict adherence to IRS guidelines.

Your financial professional will be able to help you navigate these scenarios and ensure compliance with IRS rules and regulations.

Choosing between a Roth IRA and Traditional IRA is a decision that hinges on various factors, including tax implications, age, income level, and retirement goals. While both options offer valuable tax advantages, the best choice depends on your individual circumstances and financial objectives. 

If you’re ready to take the next step, prioritize informed decision-making by thoroughly assessing your financial situation, consulting with professionals, and selecting the IRA and rollover strategies that align with your long-term retirement goals. Reach out to an experienced financial profession to get the guidance and   With careful planning and guidance, you can build a solid foundation for a secure and fulfilling retirement.

Please be advised that this presentation is not intended as legal or tax advice.  Accordingly, any tax information provided is not intended or written to be used, and cannot be used, by any taxpayer for the purpose of avoiding penalties that may be imposed on the taxpayer.  The tax information was written to support the promotion or marketing of the transaction(s) or matter(s) addressed and your clients should seek advice based on their particular circumstances from an independent tax advisor.

Equitable is the brand name of the retirement and protection subsidiaries of Equitable Holdings, Inc., including Equitable Financial Life Insurance Company (Equitable Financial) (NY, NY), Equitable Financial Life Insurance Company of America (Equitable America), an AZ stock company with an administrative office in Charlotte, NC, and Equitable Distributors, LLC.  The obligations of Equitable Financial and Equitable America are backed solely by their respective claims-paying abilities.

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