It's a common question: "Should I use a Roth IRA rather than a traditional IRA?" A similar question is, "Should I transfer money from a traditional IRA to a Roth IRA?"
Roth IRA Vs. Traditional IRA
Let's first lay out what makes these two types of IRAs different:
• In a traditional IRA, contributions may be tax-deductible, and all growth is tax-deferred. Tax is only paid upon withdrawal in retirement.
• In a Roth IRA, contributions are not tax-deductible, but qualified withdrawals and growth are tax free. Generally if your tax rate will be much lower in retirement than it is today, a Roth IRA does not make sense.
Factors Impacting Your Roth IRA Decision
Choosing the right IRA depends on your income, other investment accounts, your age, and most importantly your current and future tax rates. It is very important to use an accurate Roth IRA Calculator if you are actually going to make a decision this big.
Making an informed decision requires entering all of your actual account information, income, and expenses into a financial planning tool such as the
WealthTrace Financial Planner.
Our planning software uses the up to date federal tax code and recalculates your tax rates every year based on your changing income and tax brackets. It even takes into account tax deductions and all of your different account types. You can even figure out over how many years you should make the transfer to the Roth IRA in order to minimize taxes.
For a very quick look at how using a Roth IRA can be a benefit to you, try out our
Roth IRA Calculator. The calculator is also included at the end of this article for convenience. However, this calculator is only a starting point. For a more accurate view of your situation, you want to take into account all of your income, investments, and changing tax rates using our financial planning software, which you can
use for free. What is great about using your full financial plan for this decision is that you can see which years your tax rates are lowest, and choose these years for your Roth transfer.
Two Case Studies
Let's take a look at two examples of when a Roth IRA conversion makes sense and when it does not.
Case 1: Married couple, both 45, combined taxable income of $125,00 with $100,000 in an IRA. Their taxable income in retirement will average about $75,000 per year. I assumed their rate of return would be 7% per year. They want to know if they should transfer this money to a Roth IRA and over how many years.
I first ran the analysis where they do not transfer to a Roth IRA. Here is what I found:
• Annual Expenses That Can Be Supported By Income In Retirement: $78,000
• Investment Balance At Retirement: $330,000
• Investment Value 20 Years Into Retirement: $720,000
I then ran the analysis where the transfer their IRA to a Roth IRA over a five year period, starting immediately:
• Annual Expenses That Can Be Supported By Income In Retirement: $72,000
• Investment Balance At Retirement: $250,000
• Investment Value 20 Years Into Retirement: $650,000
In this case it does not make sense to transfer to a Roth IRA. The reason is simply that their tax rate in retirement is low enough to where a transfer does not make sense. Note too that this scenario took into account the actual federal tax code, state taxes, and their changing tax rate over time.
Let's look at a second case.
Case 2: Married couple, both 45, combined taxable income of $125,00 with $0 in an IRA today. The couple is trying to decide whether to place money in an IRA today or a Roth IRA. They plan on contributing $7,000 per year for 20 years. I assumed their rate of return would be 7% per year. Their taxable income in retirement will average about $90,000 per year.
The results are as follows:
Contribute to a Traditional IRA:
• Annual Expenses That Can Be Supported By Income In Retirement: $79,000
• Investment Balance At Retirement: $220,000
• Investment Value 20 Years Into Retirement: $714,000
Contribute to a Roth IRA:
• Annual Expenses That Can Be Supported By Income In Retirement: $88,000
• Investment Balance At Retirement: $220,000
• Investment Value 20 Years Into Retirement: $875,000
In this case, the couple is better off using a Roth IRA because their tax rate is high enough in retirement to justify paying taxes today vs. when they withdraw the money later.
No RMDs for Roth IRAs
Another nice benefit of Roth IRAs is that there are no Required Minimum Distributions (RMDs) while the owner is alive. To read more about RMDs and to use our free RMD calculator go
here.
You can also have one of our
financial planning experts help you with this important decision and your entire financial and retirement plan if you choose.
- Current age
- Your current age.
- Annual contribution
- The amount you will contribute to an IRA each year. This calculator assumes that you make your contribution at the beginning of each year. The maximum annual IRA contribution is $5,500 in 2016. It is important to note that this is the maximum total contributed to all of your IRA accounts. The contribution limit increases with inflation in $500 increments; an annual change to the contribution limit only occurs if the cumulative effect of inflation since the last adjustment is $500 or more.
If you are 50 or older you can make an additional 'catch-up' contribution of $1,000. The 'catch-up' contribution amount of $1,000 remains unchanged for 2016. In order to qualify for the 'catch-up' contribution, you must turn 50 by the end of the year in which you are making the contribution.
You can no longer make contributions to a Traditional IRA in the year you reach 70 1/2.
It is important to note that Roth IRA contributions are limited for higher incomes. If your income falls in a 'phase-out' range you are allowed only a prorated Roth IRA contribution. If your income exceeds the phase-out range, you do not qualify for any Roth IRA contribution. The table below summarizes the income 'phase-out' ranges for Roth IRAs.
| Married filing jointly or head of household | $184,000 to $194,000 |
| Single | $117,000 to $132,000 |
| Married filing separately* | $0 to $10,000 |
*For the purposes of this calculator, we assume you are not Married filing separately and contributing to a Roth IRA.
- Expected rate of return
- The assumed annual rate of return for your IRA. This calculator assumes that your return is compounded annually and your contributions are made at the beginning of each year.
- Age of retirement
- Age you wish to retire. This calculator assumes that the year you retire, you do not make any contributions to your IRA. So if you retire at age 65, your last contribution occurs when you are actually 64.
- Current tax rate
- The current marginal income tax rate you expect to pay on your taxable investments.
- Retirement tax rate
- The marginal tax rate you expect to pay on your investments at retirement.
- Adjusted gross income
- Your adjusted gross income from your tax return. This is used to determine whether or not your annual contributions might be tax deductible.
- Married
- Check the box if you are married. This is used to determine whether or not your annual contributions might be tax deductible.
- Employer plan
- Check the box if you have an employer-sponsored retirement plan, such as a 401(k) or pension. This is used to determine whether or not your annual contributions might be tax deductible.
- Maximize contributions
- Check this box if you plan to contribute the maximum amount allowed to your account each year. This includes the additional catch-up contribution available when you are age 50 or over.
- Total non-deductible contributions
- The total of your Traditional IRA contributions that were deposited without a tax deduction. Traditional IRA contributions are often tax deductible. However, if you have an employer-sponsored retirement plan, such as a 401(k), your tax deduction may be limited.
| Married filing jointly | $98,000 to $118,000 |
| Single | $61,000 to $71,000 |
| Married filing separately | $0 to $10,000 |
This calculator automatically determines if your tax deduction is limited by your income. - Total contributions
- The total amount contributed to your IRA.
- IRA total after taxes
- For the Roth IRA, this is the total value of the account. For the Traditional IRA, this is the sum of two parts: 1) The value of the account after you pay income taxes on all earnings and tax deductible contributions and 2) additional earnings from the re-invested tax savings.
Please note that for distributions to include earnings that are tax free the Roth IRA must be opened for 5 tax years. Eligible tax free distributions include those taken for death or disability, after age 59-1/2, or for a first time home purchase.
Please consult with a tax professional regarding IRA eligibility, tax deductions and your specific situation.