ACA Subsidies: Traditional IRA vs. Roth IRA for Young Adults

When your dependent child turns 18, you may wonder how their income impacts your family’s Affordable Care Act (ACA) subsidy. And depending on their earnings, you may question if they should contribute to a Traditional IRA or a Roth IRA.

Can Traditional IRA Contributions Lower Household Income for ACA Subsidies?

Yes, contributions to a Traditional IRA can lower your household Modified Adjusted Gross Income (MAGI). This is because Traditional IRA contributions are deducted from your taxable income, thereby reducing your MAGI. A lower MAGI can qualify you for higher ACA premium subsidies.

Advantage of Roth IRA Contributions in Retirement

While Traditional IRA contributions may lower your current MAGI, they will be taxed when you withdraw them in retirement. Roth IRAs, on the other hand, grow tax-free. This means that no taxes are due when you withdraw your contributions or earnings during retirement.

Consideration: Marginal Tax Rate in Retirement

To determine which type of IRA is better for your child, you should consider their expected marginal tax rate in retirement. If they anticipate being in a higher tax bracket during retirement than they are currently, a Roth IRA may be a better option.

Impact on Pretax vs. Roth Contributions

ACA subsidies can significantly affect the decision between Traditional IRA and Roth IRA contributions. Pretax contributions to Traditional IRAs can reduce your current MAGI and increase your ACA subsidy, but they will be taxed in retirement. Roth IRA contributions do not affect your current MAGI or ACA subsidy, but the earnings grow tax-free and can be withdrawn tax-free in retirement.

Conclusion

The decision between a Traditional IRA and a Roth IRA for young adults depends on their income, expected future tax bracket, and whether they qualify for ACA subsidies. If their income is low enough and they anticipate receiving subsidies, a Traditional IRA may be beneficial. However, if they anticipate being in a higher tax bracket in retirement, a Roth IRA may be a more suitable choice.

Seek Professional Guidance

It’s important to consult with a qualified insurance agent or financial advisor to determine the best option for your individual circumstances. They can help you assess your child’s income, tax status, and retirement goals to recommend the type of IRA that will maximize their savings and financial security.