If you’re not familiar, an IRA is a tax-advantaged account that allows you to invest $6,500 . Whenever you hear the term “tax-advantaged”, think “opportunity to earn more money” – as investing in an account that gets you a 20% tax-cut is the equivalent of earning 25% income on the amount of money you’re investing.
An IRA is definitely something you should take advantage of, and there’s two types of IRA:
- Traditional IRA:
- Your contributions are tax-free ✅ (via a tax credit)
- Your withdrawals are taxed ❌
- Roth IRA:
- Your contributions are taxed ❌
- Your withdrawals are tax-free ✅
Deciding whether to invest in a Traditional IRA or a Roth IRA may not have a clear answer. It can vary on your personal circumstances and is affected by factors such as your current marginal tax rate compared to your expected effective tax rate during retirement and your state income tax rate now and in retirement. We’re getting into expected values and forecasting.
One thing is very clear though. If you’re earning over $83k you can’t get a tax deduction for contributing to a Traditional IRA, so there’s no tax benefit and reason to use the Traditional IRA. And if you’re earning over $153k a year, you can’t contribute to a Roth IRA. Given these, it seems like if you’re earning over $153k a year, you can’t take advantage of either type of IRA.
Fortunately, there’s a mechanism you can take advantage of, the Backdoor Roth IRA.