Lots of questions arise during discussions about choosing the best IRA, regular or Roth. In general, your investment strategy should consider taxes (you can read more about that in this article), and that’s easy to overlook. You definitely don’t want tax to be the proverbial tail that wags the dog, but smart tax planning makes sure you keep more of what you earn.
Does Tax Planning Really Matter?
The short answer is yes! There is a big difference when you don’t plan.
The most obvious difference being the way you are taxed on contributions and withdrawals. For a traditional IRA, contributions (assuming you’re eligible) are tax deductible and withdrawals are taxable. In other words, you pay the tax when you get the money out.
For a Roth, it is the opposite, you don’t receive a tax deduction for contributions, but you don’t pay tax on withdrawals (generally). In both cases, you don’t pay any tax on gains as they occur.
If you sell a stock or mutual fund inside either a Roth IRA or a traditional IRA, there is no taxable event. Also, the amount that you can contribute to both is the same, except if you make too much money, you cannot contribute to a Roth.
Choosing an IRA
Generally speaking, younger people who are at a lower tax bracket benefit from using a Roth IRA account. In its most basic form, the question boils down to one thing: is it better to pay taxes now or later.
If you believe your rate will be lower when you take the money out, then it’s possible that the traditional IRA maybe the correct move. The only way to make the decision is to plan and model it out. Of course, things change, the biggest of which is tax rates.
Where will tax rates be when you take the money out at retirement? Who knows? I will say that individual rates are historically low, so chances are the rates will be higher in the future.
And don’t forget, Congress can change their minds about Roth IRA distributions in the future.
Don’t believe me? Social Security benefits were at one time not subject to income tax. Now they are taxable if you have too much other income. My guess would be that Congress does something similar in the future with Roth distributions.
Other Things to Consider
Additional benefits of Roth IRAs over traditional IRAs to consider:
- No required minimum distributions - With a Traditional IRA, after you’ve reach 70.5, you must start taking money out of your IRA and paying taxes on it. Roth IRAs have no such requirement
- No age limit on contributions - As long as you have taxable compensation, you can make a contribution to a Roth IRA. After you reach 70.5, you can no longer make contributions to your traditional IRA
Bonus Tip: Business owners should consider establishing a 401k with a Roth provision. This allows them to avoid the income limitation on contributions. You can read more about small business retirement plan options here.
No matter which plan is right for you, Core Group can help you get the planning right. We’re excited to share our knowledge with you and learn about how your business functions best. If you’re ready to take that next step, start by clicking the button below to schedule a free consultation today.