First things first: kudos to you for looking into a long-term savings account. You’ve made the initial step toward growing your net worth and saving for retirement. The question is, which kind of IRA is best for you: Roth or Traditional? If you’re like most Americans, you hardly know the difference between the two.
The answer truly depends on your current circumstances. Both kinds of IRA accounts have their pros and cons, so you’ll need to evaluate your situation and determine which is the best fit. Here are a few ways to do that.
Think About Your Current Tax Bracket
The biggest difference between Traditional and Roth IRAs is the tax break. When you put money away into a Traditional IRA, your contributions are tax-deductible today. That means you’ll have more money in your pocket right now simply by saving for retirement. However, you will pay taxes on that money once you withdraw it upon retirement.
With Roth IRAs, the money is taxed upfront, which can be a bummer. The nice thing is that you won’t pay taxes when you withdraw the money after you’re retired. You’re basically biting the bullet while you’re young.
Although you might be tempted to go for the Traditional IRA’s tax deductions right now, consider this: are you going to be in a higher tax bracket now or when you’re 65? Chances are, your tax bracket is lower now, so you’re technically saving money in the grand scheme of things by paying your taxes ahead of time with a Roth IRA.
This doesn’t necessarily mean that a Roth IRA is the smarter choice. It truly depends on your current situation, including your tax bracket now and later.
Consider Your Income
How much money you earn yearly can influence your decision. As long as you’re younger than 70.5 years old, you can contribute to a Traditional IRA, no matter how much money you earn (with or without a partner). Roth IRAs, on the other hand, cap the income-eligibility restrictions at $137,000 per person. If you make more than that individually, you’ll need to look into other options.
Look at the Contribution Withdrawal Penalties
Sometimes, life forces you to reach into your hard-earned savings earlier than you planned. If you need to take money out of your Roth IRA (up to $10,000), you won’t be charged any additional penalties or taxes, even if you’re under the age of 59. With a Traditional IRA, you’ll be charged a 10 percent penalty fee for the first $10,000 you withdraw before 59. You can technically work around this penalty with certain situations, such as disability, buying a home, or medical expenses. Still, you’ll pay taxes upon distribution.
Do You Plan to Keep Saving After You Retire?
Let’s say you want to pass money onto your future heirs, or perhaps you have another source of income you’ll use to fund your retirement. In that case, a Roth IRA might be the smart way to go. You can contribute money to the account up until you die. With a Traditional IRA, you can only contribute money until you’re 70.5.
Putting money into any kind of IRA is a smart move for your future. Deciding between Traditional and Roth is more circumstantial. Would you rather pay your taxes now or later? Are you planning on withdrawing the money before you’re 59? Will you move into a new tax bracket?
There isn’t a right or wrong answer to any of these questions. They’re all just factors to consider before opening a new account.