5 Steps To Decide Between A Traditional Or Roth IRA Contribution

Contributing to an IRA (Individual Retirement Account) each year is a valuable way to save for retirement and reduce your lifetime tax bill. But should you contribute to a Roth IRA or a traditional IRA? If you qualify for both, the decision is up to you, and here are a few steps to decide which to add to.

1. Complete Your Taxes

First, complete your income tax Form 1040 without the contribution in question. Include all your other deductions and credits so the only variable remaining is your IRA contribution. 

2. Calculate Your Deduction Savings

With your taxes in hand, calculate how much would be saved if you contribute to a traditional IRA. Generally, multiply the amount of your deduction by your marginal tax rate. This is your highest tax rate, and it's applied to the last amount of income earned (and therefore the first income deducted). If your marginal tax rate, for instance, is 22%, you will likely save 22 cents for every dollar deducted. 

If your marginal tax rate is high, a traditional IRA can benefit you. Many retirees have a lower tax rate in retirement, making it better to put off that tax bill until later. Someone with a low marginal tax rate, though, should consider a Roth IRA deduction instead since the benefit to current taxes may be minimal. 

3. Consider Your Effective Tax Rate

Look at your effective tax rate as well. This is the actual percentage paid for the year in taxes. This rate will generally be lower than your marginal rate — sometimes by a significant amount. This is because the percentage of tax increases as you earn more. Some taxpayers may have much more of their income taxed at a lower rate than at a higher one. 

If your effective tax rate ends up being a lot lower than your marginal rate, it may also behoove you to contribute to a Roth IRA and pay the taxes this year. Why? Your overall current tax hit may be low anyway. 

4. Look At Income-Based Credits

Your tax rate isn't the only number to crunch. In addition, look at any credits and deductions that change based on income. These include the Saver's Credit, Earned Income Credit, Child Tax Credit, education credits, and student loan interest. If your income is near any threshold — either to qualify or to be disqualified — you may want to choose the IRA option that preserves these deductions. 

5. Make Your Contribution

Once you decide whether to fund your traditional IRA or a Roth IRA, be sure you make this contribution before the deadline (usually April 15). Follow your IRA account provider's instructions to mark the contribution for the preceding year. And keep a record of the contribution with your tax forms. 

Where to Start

Want to know more about IRA contributions, tax rates, or income-based deductions? Start by meeting with an accounting company, such as Hough & Co CPA.

About Me

The Role Of Business Accountants

My name is Michael Winters and if you own a business and you don't have an accountant, you should read my blog. I didn't realize the importance of an accountant until my sister opened up a small business. She told me that she was going to hire an accountant and I wanted to know why. My sister explained why the duties of an accountant are essential for running a business. She explained that hiring an accountant was necessary for many things including getting a business started, for budgeting and to handle tax audits. After speaking with my sister, I did some research on my own to learn more about this type of job and the duties of accountants. After learning about the important role they play in a business, I wanted to share the information in a blog.



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