Millions of investors use individual retirement accounts to save for retirement, but choosing between the traditional IRA and the Roth IRA can confound even the most knowledgeable retirement saver.
In this installment of Industry Focus, Motley Fool analyst Gaby Lapera and Director of Investment Planning Dan Caplinger discuss traditional and Roth IRAs and how you can choose which one is better for you. As Dan and Gaby talk about in this clip, Roth IRAs can be especially valuable when you're in a low tax bracket for which an immediate tax deduction wouldn't produce much in tax savings. If you're in a high tax bracket, however, then the immediate deduction a traditional IRA offers makes it a more attractive proposition. Choosing a mix of both types of accounts can be the perfect solution for many.
A transcript follows the video.
This podcast was recorded on Jun. 6, 2016.
Gaby Lapera: In biology we have this thing called a dichotomous key, which helps you identify a species based on what characteristics you observe. Can you provide a dichotomous key for, in summation, how to decide which IRA is best for you?
Dan Caplinger: In general, the first thing to look at is your income. Figure out what your tax bracket is. In general, if you're in that low tax bracket, if you're in a 0-15% tax bracket, your taxes are never going to get any lower. If you're in that situation for whatever reason -- it might be because you're young and you're just getting started, it might be because you've been temporarily unemployed, or you've decided to take a break from work -- for whatever reason, if your income is in that situation, that's going to push you more toward the Roth IRA.
If you're in a high income situation where you're in the 28-39% tax brackets, that's a situation where your taxes are likely -- not necessarily for sure -- to be lower after you retire, so it makes sense to go the traditional IRA route, grab that up front deduction at the highest tax bracket possible now. With the intent that later on, you'll pay tax when you take withdrawals out of that traditional IRA. But it'll be at a lower tax rate. That should help you move forward.
The whole idea here is to end up with the most money at the end of the day. The IRS is going to get its share one way or the other. The question is when it gets it. Your decision is to be as smart as possible and to give them the least that you can get away with.
Lapera: I have a couple follow-up questions. Can you have a Roth and traditional IRA at the same time, and contribute to both of them at the same time?
Caplinger: You can. The annual limit on contributions applies to the total of all IRAs that you put in. For 2016, if you're younger than age 50, you can put in a total of $5,500 into IRAs for the year. If you're 50 or older, you get an extra $1,000, which brings it up to $6,500. You can split that however you want. You can do half in a traditional and half in a Roth. You can do it all in a traditional, you can do it all in a Roth. There is one caveat there, and that is, not everyone is allowed to contribute to a Roth IRA. If you have income above a certain six-figure amount, then you may not be allowed to contribute to a Roth for that year, so the traditional will be your only choice going forward.
Lapera: I think the figure is around $118,000.
Caplinger: I'll take your word for it, Gaby, that sounds about right.