A Roth IRA is a type of account individual investors can use to save for retirement. These retirement accounts offer tax benefits which can help grow your savings over time. These tax benefits are the main reason to choose to invest in a retirement account over other account types.
In a Traditional IRA you get a tax deduction on contributions but are taxed on distributions. The Roth is the opposite. When you make a contribution to a Roth you are putting in after-tax dollars. This means you have already paid income taxes on this money. You do not get a tax deduction for contributions made to a Roth. Instead the distributions are tax free.
How to choose between a Roth or Traditional IRA
There are a couple things to keep in mind when considering which type of retirement account to select. Both allow money to grow tax-free. This adds to the compounding effect and can make a huge difference over a long period of time. However it is important to consider the differences to help decide which account type to choose
Before you can even open a Roth it would be important to check if you’re eligible for a Roth in the first place. If you earn more than a certain level of income you become ineligible for a Roth. You can check Roth IRA income limits in our blog post or on the IRS’s website. If you are ineligible for a Roth, then you can still invest in a Traditional.
Roth Benefits
In a Roth you pay income tax today, in a Traditional IRA you pay tax in retirement. A rule of thumb that is often used to determine which account type to use is asking “Is your tax rate going to higher now, or in retirement?” If we knew the answer to this it would easy to select an account type. However this question is far from simple to answer. There are other differences between the two account types that may help make the decision.
One such of these reasons would be that a Roth does not have Required Minimum Distributions (“RMDs”). Additionally you can withdraw contributions made to a Roth tax-free (although we do not usually encourage these transactions). The combination of being able to maintain the account longer and withdrawing a portion of the money penalty-free does offer the Roth more flexibility than the Traditional.
Another benefit of the Roth is as long as all of your contributions are qualified then the earnings will not be taxed, once again if it is a qualified distribution. This additional savings on the earnings portion can be a huge benefit for your retirement savings!
As always before you make any investment decision, please, do your own research or speak to a professional. Contact us if you have any questions. Thank you for reading!
