Can You Have a Roth IRA and a Traditional?

Individual Retirement Accounts (IRAs) are essential tools in personal financial planning, providing avenues for saving for retirement with specific tax advantages tailored to different financial situations. Two of the most commonly discussed types are the Roth IRA and the Traditional IRA. A question frequently asked by consumers is: Can you have both a Roth IRA and a Traditional IRA? The short answer is yes. However, understanding the nuances of having both types of accounts is crucial for optimizing retirement savings.

Understanding IRAs

What is a Roth IRA?

A Roth IRA is a retirement savings account that allows your money to grow tax-free. You contribute after-tax income, which means you don’t get a tax deduction for your contributions. However, the significant benefit is that when you retire, you can withdraw your funds tax-free, including the earnings. This is particularly beneficial if you expect your tax rate to be higher in retirement than it is now.

Key Features of Roth IRA:

• Tax-Free Withdrawals: Qualified distributions are tax-free, which can include both contributions and earnings.
• Flexible Withdrawals: You can withdraw contributions, but not earnings, anytime without penalties.
• No Required Minimum Distributions (RMDs): Roth IRAs do not require minimum distributions during your lifetime, allowing your funds to grow longer.

What is a Traditional IRA?

A Traditional IRA allows you to defer taxes on your income. Contributions can be tax-deductible, thus potentially saving you taxes now. However, when you retire and start withdrawing money, those withdrawals are taxed as ordinary income. This is generally more beneficial if you expect your tax rate to be lower in retirement.

Key Features of Traditional IRA:

• Tax-Deductible Contributions: Contributions may reduce your taxable income now, though this depends on your income and whether you have access to another workplace retirement plan.
• Tax-Deferred Growth: Your investments grow tax-deferred, meaning you won’t pay taxes annually on gains or income.
• Required Minimum Distributions (RMDs): You are required to start taking distributions once you reach age 72.

Combining Roth and Traditional IRAs

Eligibility to Contribute to Both

Yes, you can contribute to both a Roth IRA and a Traditional IRA in the same year. However, there are annual contribution limits set by the IRS that you must adhere to, which apply to the total contributions across both types of accounts.

For 2023, the total contribution limit for both IRAs is $6,500 ($7,500 if you are aged 50 or older), divided between both accounts. Therefore, if you contribute $3,500 to a Traditional IRA, you can only contribute $3,000 to a Roth IRA.

Income Limits and Tax Implications

Roth IRA Income Limits

The ability to contribute to a Roth IRA phases out at certain income levels:

• Single Filers: Phase-out range is $138,000 to $153,000.
• Married Filing Jointly: Phase-out range is $218,000 to $228,000.
• Married Filing Separately: Phase out begins at $0 and ends at $10,000.

Exceeding these income thresholds means you cannot contribute directly to a Roth IRA, but you might still consider a "backdoor Roth IRA" strategy.

Traditional IRA Deductibility

While anyone with earned income can contribute to a Traditional IRA, the ability to deduct those contributions depends on your income and whether you’re covered by a retirement plan at work.

• Single Filers or Head of Household: Deduction is phased out if modified AGI is between $73,000 and $83,000.
• Married Filing Jointly: If covered by a workplace retirement plan, the phase-out range is $116,000 to $136,000.

Why You Might Want Both

The benefits of maintaining both a Roth and a Traditional IRA include flexibility in retirement planning and tax management. Here are a few reasons why this strategy might be beneficial:

Tax Diversification

By having both Roth and Traditional IRAs, you're effectively diversifying your tax liability in retirement. If tax rates increase or your tax situation changes (e.g., due to changes in legislation or personal circumstances), the mix of taxable and tax-free income streams provides strategic flexibility.

Strategic Withdrawals

Having both types of IRAs allows you to manage your taxable income in retirement efficiently. You can choose when and how much to withdraw from each account, potentially keeping you in a lower tax bracket.

Meeting Retirement Goals

Combining the two accounts can help maximize your contributions, especially if one account’s contributions are limited due to eligibility (e.g., income limits affecting Roth IRA contributions).

Strategies for Contribution

Contribution Strategies

Here are some strategies for contributing to both accounts over time:

• Split Contributions: Consider contributing to the Traditional IRA up to where you get the maximum tax deduction, then allocate the remaining amount to the Roth IRA.

• Forecast Tax Rates: Evaluate your current tax bracket versus expected future tax brackets. Fund the Roth IRA if you expect higher tax rates later, and the Traditional IRA if expecting lower rates.

• Account for Employer Plans: If you have a 401(k) or another employer plan, consider how those accounts impact your IRA strategy, possibly adjusting contributions to IRAs based on employer contributions and tax benefits.

Step-by-Step Contribution Process

1. Evaluate Eligibility: Check income limits for Roth contributions and deductibility limits for Traditional contributions.

2. Consult Tax Forecasts: Work with a financial planner to forecast tax scenarios and strategize contributions accordingly.

3. Distribute Contributions: Based on your strategy, allocate your total contribution between Roth IRA and Traditional IRA, ensuring not to exceed the total annual limit.

4. Annual Review: Each year, reassess your contribution strategy to account for changes in income, tax laws, and retirement goals.

Common Questions and Misconceptions

FAQs about Roth and Traditional IRAs

• Can I have a Roth IRA and a Traditional IRA if I'm covered by a workplace plan? Yes, you can contribute to both, but your ability to deduct Traditional IRA contributions might be limited by your income.

• Are my Roth IRA withdrawals always tax-free? Withdrawals of contributions are tax-free anytime. Earnings are tax-free if the account has been open at least five years and you are over 59½.

• What if I exceed my contribution limits? Excess contributions are penalized with a 6% tax each year until they are corrected. Withdraw excess contributions or apply them to the next year.

Misunderstandings Clarified

• Misconception: "I can only have one type of IRA." You can have both as long as your total contributions do not exceed IRS-imposed limits.

• Misconception: "Having both IRAs doesn’t benefit me." Combining account types offers tax flexibility and risk management as tax policies or personal financial situations change.

Conclusion

Having both a Roth IRA and a Traditional IRA can offer a strategic advantage in managing your retirement savings and tax liabilities. By understanding their differences and benefits, you can tailor your contributions to meet long-term financial goals. It’s essential to be aware of the contribution limits and tax implications of each account type and to adjust your strategy as needed to optimize your retirement planning. For further personalized advice, consider consulting with a certified financial planner.