Picking between the two flavors of Individual Retirement Accounts (IRAs) — a Roth IRA versus a traditional IRA — can seem like a simple choice. But it’s a big deal. This decision has everything to with where you see yourself later on down the road and the circumstances you expect to be in.
While making your decision, consider the attributes of the different types of IRA. (And if you’re not familiar with them, read our guide to IRAs here.) Specifically, consider these three questions as you make your choice.
1. How much do you want to access your money?
When you put money into any tax-advantaged retirement account, you limit your access to the funds. In many cases, you can’t access your retirement account without suffering a penalty until you reach age 59 and a half.
“With a Roth IRA, things are a little bit different,” says Joe Saul-Sehy, a former financial planner and the co-host of the popular “Stacking Benjamins” podcast. “You can take out your contributions before age 59 and a half without paying the 10 percent penalty. It gives you a little flexibility.”
On top of that, says Saul-Sehy, a Roth IRA allows you to withdraw your earnings early and with no penalty in certain circumstances, such as attending college or buying your first house.
A traditional IRA doesn’t offer the same level of flexibility, he says. “While I don’t recommend taking money from your retirement account very often, if you are worried about access, a Roth can make sense.”
Plus, if you want to retire early, you have the flexibility to do so with the Roth IRA.
“If you know you’re going to retire by age 50 or 55, being able to get to at least some of your money penalty-free matters,” Saul-Sehy says. He notes that, even with a Roth, withdrawing the bulk of your money without penalty before age 59 and a half is difficult. “In an early retirement situation, it can also make sense to include a taxable investment account in your planning.”
2. How old are you?
Part of the Roth versus traditional IRA choice depends on your age. “The younger you are, the more a Roth makes sense,” Saul-Sehy says.
He notes younger workers are more likely to benefit from a Roth IRA because they make less money. Since you make contributions to your Roth IRA after you’ve already paid your taxes, your money grows tax-free, and you don’t pay anything on withdrawals.
“The advantage if you are starting out with entry-level pay is that you might not have to pay federal taxes, or pay very little,” says Saul-Sehy.
On the other hand, a traditional IRA comes with a tax deduction. You pay taxes after making your contribution, resulting in a lower tax bill today. Later, though, you pay taxes when you withdraw.
“If you are older, you are likely to be making more money. So if you use a Roth, you are paying taxes in that higher bracket,” Saul-Sehy says. “A traditional (IRA) can make more sense, since you get the benefit today, and your retirement income is likely to be lower, putting you in a lower bracket later.”
3. Do you trust the government?
Dealing with the tax question when considering a Roth versus a traditional IRA isn’t just about what you pay now or later, according to Saul-Sehy. He points out that the benefits of a Roth are dependent on tax law — which may be different in the future. “What happens if the government changes its mind and the Roth no longer offers tax-free withdrawals by the time you retire?”
The Roth also comes with the advantage of not having required minimum distributions (RMDs) starting at age 70 and a half, Saul-Sehy says. An RMD is the total amount you need to take out of an IRA or another tax-advantaged account each year once you reach a certain age.
“A traditional IRA can force you to take money out of your account, potentially putting you into a higher tax bracket later and the Roth doesn’t,” he explains. “But if the government changes its mind, you could lose that and be forced into RMDs, even with a Roth.”
Roth vs. traditional IRA and your risk profile
In the end, says Saul-Sehy, it’s about your risk profile. Consider your circumstances and what matters most to you concerning your money. Consider taxes and financial flexibility. And, if you aren’t sure, consider talking to a financial professional who can help you evaluate your situation to figure out what works best for you.
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