Which IRA is Right For You?

By Sarah Brenner, IRA Analyst
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With tax season well underway, you may be considering contributing to an IRA. For many people, the IRA options are confusing. There are traditional IRAs, Roth IRAs, SEP IRAs, and SIMPLE IRAs. Which IRA is right for you? Well, if you are not an employer and are not self-employed, you may not decide on your own to contribute to a SIMPLE or SEP IRA. That leaves traditional and Roth IRAs. Which is best for your retirement savings needs?

Rules for Both IRAs
In some ways, traditional and Roth IRAs work the same. The deadline for making a contribution to both for 2015 is your federal tax-filing deadline, not including extensions. For most people that is April 18, 2016. Your traditional or Roth IRA contribution generally may not exceed your taxable compensation or earned income for 2015. However, if you are married, you may be eligible to make a spousal contribution using your spouse’s taxable compensation.  The maximum IRA contribution for 2015 if you are younger than age 50 is $5,500. For those who are age 50 or older in 2015, the maximum contribution limit is $6,500.

Roth IRAs
When you contribute to a Roth IRA, your contribution is not deductible. What is the tax benefit of making a Roth IRA contribution? If you follow the rules for qualified distributions, the earnings in your Roth IRA will be tax-free when you take a distribution. If you contribute to a Roth IRA and do not touch the funds until you reach retirement age (at least five years after your first Roth contribution), you can access all the funds in your Roth IRA, including the earnings, without tax or penalty. That is a valuable tax break for which it’s worth waiting. To achieve even more tax-free earnings, you may choose to convert an existing traditional IRA to a Roth IRA.

Unlike a traditional IRA, you do not have to stop making Roth IRA contributions in the year you reach age 70 ½.  For example, an eighty-five -year-old retiree who works a couple hours a week at the local gardening store could still make a Roth IRA contribution. However, there are income limits for Roth IRA contributions. When your modified adjusted gross income (MAGI) exceeds $116,000, if you are single, or $183,000, if you are married filing jointly, your ability to contribute to a Roth IRA begins to be phased out for 2015.

Traditional IRAs
Traditional IRAs offer tax-deferred earnings. You may also be able to deduct your traditional IRA contribution from your taxable income. This a valuable and immediate tax break. Your income level may limit your ability to deduct your traditional IRA contribution if you or your spouse are an active participant in a retirement plan at work, but your income level does not affect your ability to make the contribution. For example, a fifty-two-year-old single taxpayer with a salary of $1 million for the year, who does not have a retirement plan at work, would be eligible to make a traditional IRA contribution.  If she is not an active participant in a retirement plan at work, she could deduct the contribution. However, if she is an active participant, she may not deduct the contribution because her income is too high. You may not make a traditional IRA contribution in the year you reach age 70 ½ or in any year after.

The Choice
Both IRAs offer unique tax benefits. Which should you choose? For some taxpayers, the choice is made for you. You may not be eligible to contribute to a traditional IRA because of your age, or you may not be eligible to contribute to a Roth IRA because your income is too high.  For those who can choose, it is not necessarily an all or nothing decision. The annual contribution limit is aggregated for traditional and Roth IRAs. For example, if eligible, you could contribute $2,500 to your Roth IRA and $3,000 to your traditional IRA. There is no one right answer for everyone and the rules can be complicated. If you have questions, a good plan is to consult with an advisor who is knowledgeable about IRAs.