The debate is a long-standing one: Is a Roth or a traditional IRA a better tool to save for retirement? The debate doesn’t end the older you get. In fact, as workers approach retirement age, it’s perhaps even more important than any other time that they look closely at the relative benefits and disadvantages of each type of account.
For an older worker with solely a traditional IRA, it might make sense to consider a rollover to a Roth IRA. For someone with just a Roth IRA, there might be situations where it makes sense to open a traditional IRA. For a worker with solely a 401(k) or other workplace account who is considering moving to an IRA, rolling into a traditional IRA makes the most sense, unless he or she is ready and willing to pay income taxes on the money—which would be triggered if assets in a 401(kare moved to a Roth IRA (there are other rules on this last type of conversion, so consult with a financial adviser first).
Let’s start with the basics: With a Roth IRA, you contribute money after taxes, and qualified withdrawals come out in retirement entirely tax-free—even any investment returns you earn in the account. A traditional IRA is more like a 401(k). When contributing to a traditional IRA, you contribute pre-tax and your money grows tax-deferred. You pay taxes when you start withdrawing the money in retirement. While the contribution limit is the same for both traditional and Roth IRAs, one of the big benefits of a traditional IRA is that by contributing before your income is taxed, you are able to invest the same dollar amount with less of an impact on your bottom line.
Both types of accounts are limited to maximum contributions of $5,500 per year in 2017, plus an extra $1,000 for people 50 and older. Both types of accounts have income thresholds, and traditional IRAs limit the ability to deduct contributions based on income. Also, with a traditional IRA, unlike a Roth, if you have a retirement plan at work to which you contribute, there are special rules applying to you and, if you’re married, your spouse. More details on the rules are available on the IRS website
So, which type of account is better for older workers? Unfortunately, the best answer we can give is: It depends on your situation. For example, if you still have 30 years left to save, a Roth IRA may be your best option – maybe.
But there are specific situations where one type of account would make more sense. For example, if you’re planning to work well into retirement, and your family history and health status suggests a long life, consider the fact that you can contribute to a Roth IRA at any age, unlike a traditional IRA, which prohibits contributions after age 70-1/2.
Additionally, a Roth IRA doesn’t have required minimum distributions, whereas a traditional IRA requires distributions starting at age 70-1/2. Thus, a Roth can offer more control over your retirement income each year—and your retirement tax bill. For older workers who have a traditional IRA, it often makes sense to convert small amounts of their traditional IRA to a Roth over several years (there’s no income limit on conversions so anyone can do it), while they’re still working. That keeps the tax bill manageable—and means they avoid paying taxes on that money in retirement, when the income sources to pay bills generally are more limited.
Another area to consider is estate planning: Do you expect to leave this retirement account to a beneficiary? If so, it might be a wonderful gift to leave a Roth, because the beneficiary won’t owe any taxes on distributions. However, if your tax rate is higher than the beneficiary’s, then it might be smarter to bequeath a traditional IRA and let them pay the tax bill.
Retirement accounts are complicated animals—and if you make a mistake, it can be costly. Before you make a retirement-plan move, contact a trusted financial professional.
Eric C. Jansen, ChFC is the founder, president and chief investment officer of Westborough Massachusetts-based Finivi, which provides fee-based retirement income planning and investment management services for successful individuals and families nationwide. Do you need help planning for retirement? You can call (800)530-6635 for a complimentary consultation with a financial planner