Let’s assume that your income makes you eligible for either a traditional or Roth IRA. There are still other income factors to consider.
Let’s say that you are married with two children and, due to the responsibilities of raising children, your spouse does not work. Let’s also assume you have a mortgage. If this describes you, chances are good that your dependent and home deductions put you in a very low tax bracket. In this case, the current-year tax deduction for a traditional IRA isn’t going to be worth much, and you’re going to be much better off with a Roth IRA.
But 10 to 15 years from now, your kids will have left the nest and your spouse has returned to work. You’re also paying less in mortgage interest because you’ve paid down a large chunk of your mortgage. You’re going to be in a much higher effective tax bracket. Taking an immediate deduction with a traditional IRA suddenly looks a lot better.
The questions you have to ask yourself are “What tax bracket am I in today?” and “What tax bracket do I expect to be in later?”
If your situation changes, no big deal. This is not monogamous marriage. You’re allowed to open multiple IRAs and to contribute to whichever one makes the most sense in a given tax year. Just make sure that you keep the total contribution under the $5,500 limit.
Retirement Accounts at Work: If you have access to a 401k or comparable retirement plan at work, your ability to deduct a traditional IRA contribution on your tax return may also be phased out. For a single taxpayer, you can take a full deduction at MAGI of $59,000 or less. Above that, your deduction is phased out, and no deduction is allowed at MAGI of $69,000 or more. For a married couple, the phaseout starts at MAGI over $95,000, and no deduction is allowed at MAGI of $115,000 or more.
This doesn’t mean that you can’t contribute, mind you. It simply means you can’t deduct the contribution. In this case, the Roth IRA clearly is going to be a better option for you.
But if you are unable to contribute to a Roth IRA due to, say, high income restrictions, the nondeductible traditional IRA is still a viable option. You just need to keep track of your basis so that you are taxed only on your earnings. (This is something you’d probably want to discuss with your accountant).
When would a nondeductible traditional IRA be appropriate? If you are aggressively saving for retirement, and you have already maxed out your company 401k plan, then tossing an additional $5,500 into an IRA can be a nice bonus.
Charles Lewis Sizemore, CFA, is the editor of Macro Trend Investor and chief investment officer of the investment firm Sizemore Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.