It's always best to attack retirement saving from multiple angles. One way to do so is by using the multiple retirement accounts available to you, mainly because of their tax benefits. A 401(k) is the most popular type of retirement account, but it shouldn't be your only retirement account. Both Roth and traditional IRAs can be a great source of retirement income, and their tax breaks make them worthwhile.
If you find yourself leaning toward a traditional IRA over a Roth IRA for the potential tax deduction, here's why you might want to reconsider.
Traditional IRA deductions
For tax year 2022, the maximum amount you can contribute to an IRA (both Roth and traditional combined) is $6,000, or $7,000 if you're 50 or older. What makes a traditional IRA lucrative is the fact your contributions may be tax deductible, depending on your filing status, income, and whether or not you're covered by a retirement plan at work. If you are covered by a retirement plan at your job, here's how much of your contributions you can deduct:
| Tax Filing Status | Income | Deduction Allowed |
|---|---|---|
| Single | $68,000 or less | Full amount |
| Single | $60,801 to $77,999 | Partial amount |
| Single | $78,000 or more | No deduction allowed |
| Married, filing jointly | $109,000 or less | Full amount |
| Married, filing jointly | $109,001 to $128,999 | Partial amount |
| Married, filing jointly | $129,000 or more | No deduction allowed |
| Married, filing separately | Less than $10,000 | Partial amount |
| Married, filing separately | $10,000 or more | No deduction allowed |
Data source: IRS.
Image source: Getty Images.
If you are not covered by a retirement plan at your job, here's how much you can deduct:
| Tax Filing Status | Income | Deduction Allowed |
|---|---|---|
| Single | Any amount | Full amount |
| Married, filing jointly or separately (with a spouse not covered by a work plan) | Any amount | Full amount |
| Married, filing jointly (with a spouse that is covered by a work plan) | $204,000 or less | Full amount |
| Married, filing jointly (with a spouse that is covered by a work plan) | $204,001 to $213,999 | Partial amount |
| Married, filing jointly (with a spouse that is covered by a work plan) | $214,000 or more | No deduction allowed |
| Married, filing separately (with a spouse that is covered by a work plan) | Less than $10,000 | Partial amount |
| Married, filing separately (with a spouse that is covered by a work plan) | $10,000 or more | No deduction allowed |
Data source: IRS.
A traditional IRA is similar to a 401(k) in that contributions lower your present-day taxable income, but you'll owe income taxes on any withdrawals made in retirement -- which you will eventually have to do because traditional IRAs have required minimum distributions (RMDs) once you turn age 72.
The deduction may not be worth it
The main thing that separates a traditional IRA from a Roth IRA is when you receive your tax break. With the traditional IRA, the tax break is on the front end with the potential tax deduction. With a Roth IRA, you can't deduct your contributions, but you can take tax-free withdrawals in retirement (beginning at age 59 1/2). Even if you're eligible for the traditional IRA tax deduction, you may find you're better off going with a Roth IRA and taking the tax-free withdrawals on the back end.
If you're relatively early in your career and your tax bracket is likely to be higher when you retire, it makes sense to pay taxes now instead of later when it'll cost you more. This is especially true when you consider how much investments can compound over time. If you make a one-time $6,000 investment in a Roth IRA and earn 10% annually, on average, for 25 years, you would have accumulated over $65,000. Since it's in a Roth IRA, that entire amount could be withdrawn tax-free in retirement, easily saving you thousands in taxes. In a traditional IRA, there's a chance the taxes you'd owe on that amount would offset the benefits you received from the tax deduction.
If you're in your peak earning years and this is likely to be the highest tax bracket you'll ever be in, it makes sense to take the tax break now when it's more valuable. If that isn't the case, the benefits from the possible deduction likely won't outweigh the benefit of having your money grow and compound tax-free in a Roth IRA. You'll never get out of paying taxes completely, but you can be strategic about when you pay them and how much it ultimately costs you.
