Dear Garden State Trust:
I have $6,000 to put into an IRA before I file my tax return for 2020. Which is better, the traditional IRA or the Roth IRA?
There is no simple answer to your question, unfortunately. Do you qualify for the tax deduction for the contribution to a traditional IRA? It offers an immediate income adjustment and savings in federal and state income taxes.
The downside for the traditional IRA is that all retirement withdrawals are fully taxable as ordinary income, even long-term capital gains. If one is in a lower tax bracket in retirement, this may not be a concern, but future tax brackets are unpredictable. What’s more, distributions from a traditional IRA are required once one reaches age 72. Taxable IRA distributions also may increase the taxes on one’s Social Security benefits and one’s Medicare premiums.
These potential tax traps are avoided with the Roth IRA, as all distributions will be fully tax free after age 59½, provided only that the account has existed for five years. There are no required minimum distributions during your life. The difficulty with the Roth IRA is that the hit to one’s cash flow is more severe without the current deduction, but you suggested that you already have the $6,000 in hand for a contribution. By the way, if you are older than 50, your IRA limit is $7,000—the extra $1,000 is called a “catch-up” contribution.
One more factor, in case you are worried about tying up your savings. Contributions to a Roth IRA may be withdrawn without tax penalty at any time. That should be a last resort, but it’s good to know that the funds may be available for an emergency.
These tax considerations, although significant, are less important than making a full contribution to one or the other IRA form early in one’s career. The more time that one is invested in the market, the better the odds of having a financially secure retirement.
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