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In Your 20s or 30s? Hedge Between IRA Types

HUNT VALLEY, Md. (TheStreet) -- If you are able to contribute to a Roth nondeductible 410(k) and IRA or a traditional deductible 401(k) and IRA, which do you choose?

The correct answer will not be known until you retire; the sole factor in determining which is better for you lies in the tax bracket in the year of deposit versus the tax bracket in year of withdrawals.

IRA

If you think your tax bracket will be the same or lower today versus the future, the Roth IRA will come out the victor. If you think your tax bracket today is going to be higher compared with the future, the traditional IRA wins out.

When people are young and starting their careers, and income will hopefully increase, the Roth IRA is the best candidate. The Roth IRA also comes with a unique benefit the traditional IRA does not have: the ability to withdraw contributions at any time without penalty or taxation.

You cannot withdraw from a Roth 401(k) until you leave the contributor company or you reach age 59.5. If you retire from a company with a Roth 401(k), though, it can be rolled into a Roth IRA. A Roth IRA allows you to withdraw all contributions made into the plan without penalty and income taxation. If you contribute $10,000 to a company Roth 401(k) and roll it over to a Roth IRA and you contributed $5,000 to the Roth IRA, you have a $15,000 basis in the Roth IRA. If the Roth IRA is worth $20,000 you may withdraw the full $15,000 without penalty and/or taxation. If you withdraw the remaining $5,000, you would report that as income on your tax return and pay a 10% ($500) penalty.  

As your income rises in your later 30s, you would begin to gradually shift your 401(k) contributions toward a 50-50 allocation between traditional and Roth 401(k) allocations. It is foolish to assume it is only beneficial to have all Roth nondeductible or all Traditional deductible allocations.

Since we do not know what the future holds, your best bet is to hedge between the two.

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Andrew Tignanelli, CFP, CPA, is president of Financial Consulate, based in Hunt Valley, Md., and a member of NAPFA, the National Association of Personal Financial Advisors.

This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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