Should I Invest in a Roth IRA or a Traditional IRA?
Joseph G. Salpietro, ChFC®, AIF® XPYRIA Team Insights
Many articles have been written; few have made it clear. There is only one primary consideration in determining if a Roth makes sense to consider. There may be other considerations, but if the statement below is not true, conversion is not likely for you and Roth investing directly may only provide for retirement tax diversification.
IF your federal tax rate is lower today than it will be when you plan to withdraw money from your retirement accounts, THEN:
- A Roth account has the advantage for new savings. Annual income limits apply.
- Conversion from a Traditional IRA to a Roth IRA is advantageous. It generally makes the most sense to pay taxes owed from assets outside of the IRA. You may have to pay a 10% excise penalty if you withdraw from the IRA to pay taxes and are below age 59 1/2.
You will not receive any tax deduction for a Roth contribution in the year you contribute new money, and you will pay taxes on the entire value converted in the year the conversion takes place. Your principal and earnings* will all be tax-free when withdrawn (*earnings are subject to a five-year rule). Moreover, Roth IRA assets are not subject to Required Minimum Withdrawal (RMD) Rules at age 72-- providing you with some level of taxation control in your later years.
Special opportunity to convert to a Roth IRA in a DOWN-MARKET environment:
Given the size of recent market declines on investment assets, you may consider a conversion of Traditional IRA assets to Roth IRA assets because the account value is currently depressed and presents an opportunity to convert with less tax dollars to be paid than if the account was at a higher value. As your account value recovers in the Roth IRA (if not materially changed), your tax-free benefit when money is needed will be enhanced. For example, if you had $100,000 invested and the current market value is $70,000 due to market declines, a 25% taxpayer will pay $17,500 today to convert the assets to a Roth IRA versus $25,000 if the account was converted at the higher value. The ultimate benefit, as described above, still applies. Plus, you get an additional $7,500 tax reprieve. It is important to note that the if-then statement above is still the primary driver of your decision and ultimate advantage.
*Other rules and conditions may apply. As with all tax related matters, you should consult your tax professional before considering any changes to your retirement accounts. XPYRIA Investment Advisors, Inc. is not a tax expert, and we profess no expert knowledge in such matters.
