When planning for retirement, every decision can have serious consequences, including the type of IRA you contribute to. Roth IRAs get a lot of attention because you can make tax-free withdrawals in retirement, but these accounts aren't a good fit for everyone. Here are three reasons to consider a traditional IRA instead.
1. You're in a higher tax bracket now than you think you'll be in when retired
Your goal in choosing between a traditional and Roth IRA is to pay the least in taxes. Roth IRAs make sense if you believe you're in a lower or the same tax bracket today as you will be in retirement. You pay taxes on your initial contributions, and then all your earnings are tax-free -- assuming you wait until you're 59 1/2 or older and have had the account for at least five years before you begin making withdrawals.
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But if you think you're in a higher tax bracket today than you will be in when you're retired, paying taxes on your initial contributions could cause you to lose a larger percentage of your income to the government. In that case, a traditional IRA is a better fit. Your contributions reduce your taxable income in the year you make them, but unlike a Roth IRA, you must pay taxes on your traditional IRA retirement distributions. This is typically the best route for those who are at the peak of their careers, as many people see their annual income decline in retirement. This could change your tax bracket, and then you'll share a smaller amount with Uncle Sam.
2. You'll get a tax break this year
Your traditional IRA contributions aren't taxed, so any money you put in this account reduces your taxable income this year. Depending on how much you made this year, the amount of your contribution, and how the tax brackets fall, a traditional IRA contribution could push you into a lower tax bracket, enabling you to keep even more of your hard-earned cash.
But you're limited in how much of a tax break you can get. You're only allowed to contribute up to $6,000 to an IRA in 2019, or $7,000 if you're 50 or older. This limit applies to all of your IRAs -- traditional and Roth -- not each account individually. Contributing more than this results in a 6% excise tax on the excess amount for every year it remains in your account. But you can avoid this by removing the extra amount from your account before the tax deadline for the year.
3. Anyone can open a traditional IRA
Roth IRAs have income limitations that prohibit high earners from contributing directly to them, but anyone who earns income during the year can open and contribute to a traditional IRA. This opens up a loophole for higher earners who want to contribute to Roth accounts but are unable to do so directly.
If you're one of those higher earners, you can open a traditional IRA and make contributions up to the annual limit, then do a Roth IRA conversion in the same year. This is called a backdoor Roth IRA. It's a few extra hoops to jump through, but it lets you contribute to a Roth IRA regardless of your income. Think carefully before doing this, though. If you believe your high income will drop off in retirement, you may be better off sticking with the traditional IRA so you can take advantage of the smaller tax bill.
You're not limited to a traditional or Roth IRA. You can contribute some money to both. But most people tend to favor one over the other. If any of the above points sound applicable or appealing to you, consider putting the bulk of your investment savings into a traditional IRA this year.
