Using a Traditional IRA to Fund Retirement
In a previous post, we looked at the benefits of using a Roth IRA to save for retirement. While Roth IRAs are an incredible asset to have as part of your retirement plan, a traditional IRA may also work in your favor. What are some factors to consider when deciding to invest in a traditional IRA?
Tax Treatment
Traditional IRAs are funded with pre-tax money, and the taxes are paid when money is withdrawn from the account in retirement. The tax-deferral benefit gives you more money to invest because you don’t have to pay taxes out of it up front. This type of IRA would be beneficial to you if you think you will be in a lower tax bracket in retirement then you are in now. By deducting IRA contributions now, your short-term taxes will be less. When you start withdrawing the funds in retirement, you will owe less because of your lower income bracket. The goal is to pay the least amount of taxes possible.
Take a look at this comparison between Roth and Traditional IRAs based on your tax rate:
| If your tax rate is LOWER in retirement | If your tax rate is HIGHER in retirement | ||
Roth | Traditional | Roth | Traditional | |
Current tax rate | 25% | 25% | ||
Tax rate in retirement | 15% | 33% | ||
Annual investment | $5,500 | $5,500 | $5,500 | $5,500 |
After-tax value in retirement* | $555,902 | $572,898 | $555,902 | $472,835 |
* Assumes a 7% annual return and 30-year time horizon; traditional IRA includes invested tax savings.
(https://www.nerdwallet.com/blog/investing/roth-or-traditional-ira-account/#taxes)
Eligibility
Unlike the Roth IRA, traditional IRAs do not have income limits, so as long as you earn wages, you are eligible to contribute up to $5,500 a year, $6,500 if you are over 50. You must begin taking required minimum distributions (RMDs) at age 70½, which is also the cut-off age for making contributions.
Withdrawals
If you are under age 59½ and end up in a situation where you need extra money and want to withdraw from your IRA early, you will face a hefty 10% withdrawal penalty along with the taxes owed at your current rate. The IRS does allow penalty-free (but not tax-free) withdrawals for these particular qualified distributions:
Buying your first home: You are allowed to withdraw up to $10,000 to buy or build your first home.
Medical expenses: If you have any unreimbursed medical costs, health insurance premiums after 12 weeks of unemployment, or costs related to becoming disabled before you turn 59½, you can use your IRA to pay for them.
College costs: The IRS lets you use your IRA to cover tuition, fees, books, supplies, or other costs related to higher education. The money doesn’t have to be for you; you can use it cover costs for your spouse and the children and grandchildren of you or your spouse.
IRA inheritance: If you are the beneficiary of an IRA, you can withdraw the money without penalty as long as you don’t name yourself as the account owner or roll it into another IRA.
Rollovers
Another benefit of traditional IRAs comes in the form of rollovers. Many people have multiple 401(k)s from previous employers and would like to have the money all in one place. Because most employer-sponsored retirement contributions are pre-tax, you can roll the funds into an IRA with no tax penalty. Additionally, if you do a direct transfer of funds into an IRA, you aren’t limited in the amount of transfers you make.
What Next?
The type of IRA that is best for you depends on your personal situation and preferences. When making important financial decisions like this, it is always best to rely on the experience and expertise of a financial planner in order to set yourself up for retirement success. If you are considering investing in an IRA, give me a call at (717) 283-4186 or email me at dniggel@keywealthpartners.com. I look forward to helping you choose the best IRA to fund your unique retirement goals.
About David
David Niggel, CFP®, ChFC®, AIF® is the founder and president of Key Wealth Partners, LLC, an independent wealth management firm serving individuals, families, and business owners. Along with over a decade of financial services experience, he has advanced knowledge and training in providing holistic financial planning with fiduciary and ethical care, holding the CERTIFIED FINANCIAL PLANNER™, Chartered Financial Consultant®, and Accredited Investment Fiduciary® certifications. With hands-on entrepreneurial experience, he has the unique ability to help clients meet both their individual and business goals. Based in Lancaster, he serves clients through the York, Harrisburg, Hershey, and Central, Pennsylvania areas. Learn more by visiting www.keywealthpartners.com or connecting with David on LinkedIn.