Yes, it is possible to have both a Roth IRA and a traditional IRA. In fact, if you qualify, you should have one of each. Why? Two words: tax diversification.
If you do choose to open two IRA accounts, you will have to consider the the IRS’s maximum annual contribution, which applies to both Roth IRAs and traditional IRAs. In 2014, the maximum contribution was $5,500 ($6,500 if you’re 50 or older) or your taxable compensation for that year, whichever was less. Notice that you need to have a job to qualify. If you – or your spouse, if filing jointly – don’t have any taxable income during a given tax year, you cannot contribute toward either a Roth or a traditional IRA.
To illustrate, if your taxable income is higher than $5,500 and you’re under 50, you could contribute to both a Roth IRA and a traditional IRA up to a combined maximum of $5,500 a yearer. You could contribute $2,250 in each, $4,000 in one and $1,500 in the other, or any combination you prefer, as long as the combined contribution does not exceed the annual maximum.
Another limitation to consider is that if you’re a higher-income worker (above $100,000 a year) or married filing separately, you may face restrictions on how much you can contribute toward a Roth IRA. More details on Roth IRA limitations at the end of the article.
That’s the skinny on whether you can or can’t have both a Roth IRA and a traditional IRA, but let’s flesh out that answer by dealing with some other questions you probably have in mind. Such as, what is the difference between a Roth IRA and a traditional IRA? And which one offers the best deal?
In this article
What’s the Difference?
The main difference between Roth IRAs and Traditional IRAs is how they are taxed.
Roth contributions are after-tax, so you’ll never have to pay taxes on withdrawals of your contributions or the interest they generate, as long as you wait until you’ve reached age 59 ½ to cash in. The catch is you cannot deduct your contributions from your taxable income, so you don’t receive immediate tax savings.
Traditional IRAs are the exact opposite. Contributions to a traditional IRA can be pre-tax, which means they can reduce your taxable income. However, you will have to pay income tax on withdrawals of all your earnings and any contributions you deducted on your taxes. They give you a break at the front end and then hit you with a tax bill when you retire.
Valuable Tax Savings
Both types of IRA offer valuable tax savings. Which one is best for you will depend on your current tax rate and what you think your tax rate will be when you retire.
If you think your tax rate will be much lower when you retire, then a traditional IRA may offer the most savings. On the other hand, if you think your tax rate will be higher when you retire or that the growth of welfare spending is unsustainable and that income tax rates will be higher for everyone when you retire, you may prefer paying your taxes upfront and invest in a Roth IRA.
Roth IRA Advantages
If you’re young, a Roth IRA may offer the best deal because there’s a good chance the tax you pay on the interest generated by your contributions over several decades will outweigh the savings provided by pre-tax contributions.
One reason to prefer Roth IRAs is that your Roth contributions can be worth more in retirement. Roth contributions are already taxed, which allows you to contribute more on a tax-advantaged basis. Remember the $5,500 annual contribution limit. Over time, the extra savings add up.
Another benefit Roth IRAs offer is that withdrawals from Roth IRA don’t count as income. This is important when you retire because whether your Social Security benefits are taxed or not will depend on taxable income and your traditional IRA withdrawals, but not your Roth IRA withdrawals. If you have enough money in your Roth IRA, you may be able to stay in the lowest tax bracket but still have enough money to meet your retirement needs, and even some of your retirement “wants.”
Anyone who has taxable compensation from a job can contribute toward a traditional IRA, but the same doesn’t apply to Roth IRAs. High-income workers are limited, and even excluded, from contributing.
Taxpayers with a modified adjusted gross income above $114,000 if single, or $181,000 if married filing jointly. Married taxpayers filing separately who have lived together at any time during the tax year only qualify for a limited reduced contribution and are excluded altogether if their MAGI is above $10,000. The limits vary depending on your filing status.
In case you’re wondering, your modified adjusted gross income is your taxable income with certain nontaxable sources of income and deductions, such as foreign earned income, added back. Find a modified adjusted gross income calculator published by the IRS.
Do Both, If You Can
If you qualify, open both a Traditional IRA and a Roth IRA. This will add tax diversification to your portfolio and allow you to reap the benefits of both pre-tax and after-tax retirement accounts. However, you may want to invest more in your Roth IRA, particularly if you’re young.