Traditional IRA Versus Roth IRA? What is Right for Public Service Workers

The most common way for public service workers to save for retirement is their pension and/or 401(k) type plan, such as a Thrift Savings Plan (TSP) for federal workers or a 403(b) for educators and state and local workers. But there are other retirement savings vehicles beyond what can be found in your government jobs with tax benefits that are often not fully understood or used. These are called Individual Retirement Accounts or IRAs. You can contribute to your 401(k), 403(b), or TSP and contribute to an IRA.

According to the IRS, there are two types of IRAs. One is known as the traditional IRA which you can save up to $6,000 per year if under 50 and up to $7,000 if you are older than 50 in 2022. You or your spouse must have compensation income such as wages that exceed what you can contribute. You can also get an income tax deduction if your income is under a threshold with a traditional IRA.

The benefit of the traditional IRA is that you can save beyond your 401(k) or pension in your job. But when the money comes out in retirement, you would pay your ordinary income taxes on the distributions. But you benefit from tax-free growth on the earnings.

If you can take advantage of the income tax deduction, a traditional IRA might be the preferred way to save beyond your pension or 401(k). But if you are past the income threshold, it might be better to save in a Roth IRA. But as I will explain, the Roth IRA is typically the better choice for savings beyond your workplace plan.

The Roth IRA is my preferred choice to save beyond your workplace retirement plans. With the Roth IRA, you put in after-tax money, and it grows tax-free and is distributed tax-free in retirement. So the benefits here are tax-free growth and earnings. So all of the money comes out tax-free when you are in retirement, which is the major benefit.

The drawback of the Roth IRA is that you don't get an income tax deduction. But for government workers above the income threshold, you will not be getting it anyways. So I would skip trying to get a small income tax deduction and go for the tax-free growth and earnings, which should be a much greater long-term benefit.

In addition, the Roth IRA has more exemptions for taking the money out before retirement than the traditional IRA. For instance, the principal always comes out tax-free. So with the Roth IRA, you get more flexibility than the traditional IRA.

But keep in mind that a direct contribution to a Roth IRA also has an income threshold; if you make too much money, you will have to do a backdoor Roth IRA. This is where you first contribute to a traditional IRA and then convert the money over to a Roth IRA. This enables you to avoid the direct contribution, so instead, you are doing a Roth conversion which is allowed with any income.

If you contribute to a Roth IRA and are over the income threshold, you will have to remove the excess contribution and earnings by your tax filing; this is called re-characterization. Try to know the income limits on direct Roth IRA contributions as you don't want to contribute over the income threshold. This can create an additional tax liability plus penalties until corrected.

How should government workers approach the IRA, both traditional and Roth? First, you should max out your 401(k), thrift, or 403(b) plan. Or, if you don't max out the plan, you should contribute up to the government match, which could be between 4-6%. Second, contribute to a Roth IRA.

Be sure to talk to a financial planner to examine which choice is right for your circumstances. Then, reach out to me on the contact page below, and we can talk about the various options.

*This content is developed from sources believed to be providing accurate information. The information provided is not written or intended as tax or legal advice and may not be relied on to avoid federal tax penalties. Individuals are encouraged to seek advice from their tax or legal counsel. In addition, individuals involved in the estate planning process should work with an estate planning team, including personal legal or tax counsel. Neither the information presented nor any opinion expressed constitutes a representation of a specific investment or the purchase or sale of any securities. Asset allocation and diversification do not ensure a profit or protect against loss in declining markets.