A Roth IRA and a traditional IRA (individual retirement account) offer valuable retirement-planning benefits, but with different structures, income limits and pros and cons.
- Traditional IRA: A traditional IRA helps you save for retirement and might give you a tax break today. For example, if you contribute $4,000 to a traditional IRA this year, you may be able to deduct that amount on your tax return. This allows you to enjoy a nice break on your obligation to the IRS — subject to income limitations — while your investment continues to grow. You can continue to contribute funds up to the annual contribution limit every year: $6,000 for those under 50 and $7,000 for those over 50 in 2021. You can start making penalty-free withdrawals at age 59 1/2, and you must begin making withdrawals by the age of 72. Whenever you do start taking money out, though, you will pay taxes on the deductible contributions you made and the investment gains.
- Roth IRA: While a traditional IRA defers your taxes, a Roth IRA is not designed to give you immediate tax benefits. So, if you decide to contribute $4,000 to a Roth IRA this year, it’s all after-tax money. The benefits shine when you begin to make withdrawals — all the compounded growth that has built up over the years is yours to keep. The annual contribution limits are the same as a traditional IRA. However, there is no timestamp for when you must make those withdrawals. You can wait longer to access the cash, and if you wanted, you could leave the money in the Roth IRA forever and pass the money on in your estate plans.
Roth IRA vs. traditional IRA: How they compare
Both of these IRAs are sound choices that will help you prepare for the future.
A common piece of the Roth IRA vs. traditional IRA conversation is the assumption that you’ll be in a lower tax bracket when you retire. While that is possible, it’s also impossible to accurately predict your tax bracket decades down the road. Instead, look at that road to retirement as a downhill ski slope. Think of your savings as a snowball rolling down that slope: You want it to get bigger and bigger as it reaches the bottom.
With that image in mind, it’s important to ask yourself a question: Do you want to carve out a chunk of it for taxes when you’re finally ready to leave the workforce, or would you rather keep that whole snowball for yourself? With a Roth IRA, you’re fulfilling your tax obligation at the top of the hill when the snowball is the size of your fist. At the bottom of the hill, it’s the size of a car. Consider it a way to thank yourself later: You paid the taxes early so that you can enjoy that whole car-sized chunk of cash.
If you’ve been contributing to a traditional IRA throughout all those years, the government will be waiting for its share.
How to check your IRA eligibility
If you or your spouse have earned income from a job, you’ve checked off the first box on IRA eligibility. To take advantage of the tax breaks of an IRA, though, you’ll need to make sure you meet the government’s additional requirements. Income thresholds vary widely based on a few key factors: your filing status, how much you’ll earn this year and whether you also have a workplace-based retirement plan.
For example, if you file as single or head of household in 2021 and are covered by a retirement plan at work such as 401(k), you need to make less than $66,000 to enjoy the full deduction to a traditional IRA. If you’re married and you are earning $208,000 or more, you are unable to contribute to a Roth IRA. Be sure to review the IRS’ updated contribution limits and deduction requirements to verify if you can enjoy the full benefits of an IRA. And if you’re concerned about income restrictions, you can consider setting up a backdoor Roth IRA, which involves some additional complications but can be worth it for high-income taxpayers.
Here are some additional factors to consider when comparing a Roth IRA and a traditional IRA.
Your current age: If you’re earlier in your career, comparing the benefits between a Roth vs. traditional IRA is especially important. The longer you have between now and retirement, the more that the prospect of compounded tax-free growth in a Roth IRA stands out as a big differentiator.
Your family history: While retirement is often discussed in a window around the traditional age of 65, it’s important to note that people have been working longer — and they will continue to do so in the future. If you have a history of longevity in your family and can envision a retirement that stretches well into your 80s or 90s, a Roth IRA’s lack of requirements for withdrawing money can be especially important.
You can have both: As you compare Roth vs. traditional IRAs, you should know that this isn’t an either-or equation. Provided that your annual contributions can stay within the government’s guardrails, you can put both of these investing vehicles to work and enjoy a balance of tax breaks between now and years into the future.
How to choose the right IRA for you
Regardless of how you decide to divide your funds between a traditional IRA or Roth IRA, it’s important to compare options to diversify your investments with an approach calibrated to your risk tolerance and your retirement timeline.
If you want to be in full control over the investing decisions, look for firms that empower you with a full slate of educational offerings about the market and potential places to grow your money. If you would rather put your IRA on cruise control, a target-date retirement fund or robo-advisor that can deliver sophisticated, low-cost investing tailored to your needs will be a simple way to save.
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