Which type of IRA should I contribute to?

IRA’s, or Individual Retirement Accounts, are tax advantaged accounts for saving and long term investing for retirement. The two most common types are Roth and traditional. You can make contributions every year, and you can have both types. So how do you know which type to contribute to this year?

Which IRA you want to use is mostly a matter of when you want to pay taxes.

Since a traditional IRA means paying taxes when you withdraw funds in retirement, most advice says to contribute to a traditional IRA when your current tax rate is higher than what you think it will be in retirement. You’d rather pay the lower rate later than the higher rate now.

A Roth IRA is the opposite. Since you pay taxes on the contribution, but not at withdrawal, the general guideline is to choose a Roth when your current tax rate is lower than what you think it will be in retirement. Pay the lower rate now rather than the higher rate lower. But it’s not always that simple.

Eligibility rules mean not everyone can get take full advantage of the traditional IRA tax deduction, or even contribute to a Roth IRA at all.

The eligibility rules apply to contributions, not simply having these types of accounts. So even if you aren’t eligible in one year, that doesn’t mean you won’t be next year or that you can’t keep your IRA, whichever type it is.

The eligibility rules for a traditional IRA determine how much of your contribution you can deduct from your taxes. You can still contribute, you just won’t get the upfront tax deduction advantage – meaning this option isn’t as valuable to you.

For a Roth IRA, the eligibility rules determine how much, if at all, you can contribute to a Roth IRA. Since the tax advantage comes at the other end when you withdraw, there’s no deduction upfront and the contribution itself is limited.

These limits change frequently and the IRS is the best source for the current ones. Here are the IRS guidelines for Roth contributions and here are the guidelines for traditional IRA deductions. We’re just going to cover which variables you need to be aware of and how they generally affect your eligibility.

You need to consider your tax filing status, your income (technically your Modified Adjusted Gross Income), and whether you (and your spouse if you have on) are covered by a retirement plan like a 401(k) at work.

Here’s a quick example to show how this works: Taylor is married, and files taxes as “married filing jointly.” She is covered by a retirement plan at work (her employer offers a 401(k)) but her spouse is not covered. The modified adjusted gross income (MAGI) they report together on their tax return is $135,000. Taylor wants to contribute to an IRA but isn’t sure which one she should choose.

In this case, the IRS limits make the choice for her. For her filing status and since she is covered by a retirement plan at work, the deduction limit for a traditional IRA is $124,000. If she and her partner made between $104,000 and $124,000 she could take a partial deduction, or the full deduction if it was below $104,000. But since their MAGI is over the limit, she is not allowed to take a deduction for contributing to a traditional IRA. That eliminates one of the big advantages of that option. On the other hand, the Roth contribution limit for her tax filing status is $196,000. Their MAGI is well below that so she is able to contribute to her Roth IRA up to the full allowable amount this year.

The IRS doesn’t exactly make it simple to know which type of IRA you can contribute to. If you’re not sure which is the right choice for you BrightDime’s coaches are here to help.