The Modest Millions Show - Personal Finance, Budgeting, Early Retirement, Financial Independence and Getting Out of Debt Tips for Average Folks

MM008: Roth vs. Traditional IRA Which is Right for Me?

04.26.2017 - By Phil Wocken - Personal Finance, Budgeting and Early Retirement EnthusiastPlay

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What do you do when you have the option to contribute to either a Roth IRA or a traditional IRA? Is it better to take the tax break now in the hopes that the added investment juice and a projected lower tax rate in retirement leads to a larger nest egg? Or, is it better to use post-tax dollars now and not pay any taxes in retirement. We break it down and compare Roth vs traditional IRAs in this week's episode.


* Recap of Roth IRA accounts

* How Traditional IRAs work

* A look at historical income tax rates

* Why I love Vanguard's IRA products

* Apples-to-apples comparison of Roth vs. traditional IRAs

* Figuring out if Roth or Traditional IRAs works best for your situation


Before we dive in, let’s scoop a big helping of disclaimers. As I’ve said in previous episodes, and especially with this episode, I am NOT a professional, and when it comes to setting your actual financial plan, you should consider seeking professional advice. My goal here is to explore concepts and share with you some of the interesting tidbits that I uncover when doing research for our family’s personal finances, so you can go into conversations with “the pros” armed with information or if you go the DIY approach, you can be informed so you can make your own decisions.

With that out of the way, let’s dive right in and recap how Roth and Traditional accounts work.

For the purposes of today’s conversation, we’re going to focus mostly on Roth IRAs versus Traditional IRAs, rather than Roth IRAs versus Traditional 401(k)s, just so we can keep a bit more of an apples-to-apples comparison.

Recap of Roth Accounts

As with anything put forth by the IRS, there are a bunch of rules with Roth IRAs.

You can contribute to a Roth IRA at any age.

The amount you can contribute to a Roth IRA:

Can't exceed the amount of income you earned that year

Can't exceed the IRS-imposed limits; for the 2016 and 2017 tax years:

* If you're under age 50, you can contribute up to $5,500

* If you're age 50 or older, you can contribute up to $6,500

Could be reduced—or even eliminated—based on your modified adjusted gross income

* If you’re single, $117,000–$132,000

* If you’re married filing jointly, $184,000–$194,000

* If you’re married filing separately, $0–$10,000

* If you can’t contribute, you may be able to still get your money into a Roth IRA through something called a backdoor Roth. It’s a complicated process, so we’ll dedicate a specific episode to that strategy

You can't deduct your Roth IRA contributions, which means you’ll be using after-tax dollars to contribute to the IRA, but you'll never pay taxes on withdrawals of your Roth IRA contributions. And you won't pay taxes on withdrawals of your earnings as long as you take them after you've reached age 59½ and you've held onto the funds for at least five years.

There are no penalties on withdrawals of Roth IRA contributions. But there's a 10% federal penalty tax on withdrawals of earnings. There are some select exceptions to the 10% penalty if you receive distributions before you're age 59½ where you may not be subject to the 10% federal penalty tax:

Due to your disability or death

Distributed to a reservist who was ordered or called to active duty after September 11, 2001, for more than 179 days

A first-time home purchase (lifetime maximum: $10,000)

College education expenses

Substantially equal periodic payments taken under IRS guidelines

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