Taxes Made Simple

The conventional wisdom when it comes to choosing between a Traditional IRA and a Roth IRA is that it comes down to your current income level, and how you expect that to compare to your income level during retirement.

Given the high probability that Pam will be in a lower tax bracket once she retires than she is in at the moment, it makes sense for her to contribute to a traditional IRA. The value of receiving a deduction now, while she’s in the 28% tax bracket likely outweighs the value of being able to make tax-free withdrawals once she’s retired.

EXAMPLE 2: Laurie is a college student who recently got a raise at her summer job. She’s going to earn approximately $5,000 this summer. Laurie doesn’t work during the school year.

A Roth IRA is almost certainly the best option for Laurie to take. At the moment, she’s only in the 10% tax bracket, so the value of a deduction from an IRA contribution isn’t that great. The ability to grow her money (and eventually withdraw it) free of tax in a Roth IRA is much more valuable.

EXAMPLE 3: Carlos is currently unmarried, and earning $80,000 per year. His employer offers a 401(k) plan to which he can contribute. After making the maximum contribution to his 401(k) (discussed in the next section), Carlos still wants to invest more money for retirement.

Despite the fact that a contribution to a Traditional IRA would be appealing, he has no option here. Because he has a retirement plan at work, and because of his income level, he is ineligible for a deduction for a Traditional IRA contribution. If he wants to contribute to an IRA, he must use a Roth IRA.

If Carlos made, for example, $200,000 annually, he would be unable to contribute to either type of IRA because his income would exceed the limits for both Traditional IRAs and Roth IRAs.

Related Reading:

• How Do Traditional IRAs Work?
• The Rules for Investing in a Roth IRA

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"Very easy to read and is a perfect introduction for learning how to do your own taxes. Mike Piper does an excellent job of demystifying complex tax sections and he presents them in an enjoyable and easy to understand way. Highly recommended!" Aaron Torres

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