Editorial Note: The content of this article is based on the author’s opinions and recommendations alone and is not intended to be a source of investment advice. It may not have not been reviewed, commissioned or otherwise endorsed by any of our network partners or the Investment company.
Updated on Wednesday, January 8, 2020
An IRA, or individual retirement account, is one of the most accessible ways to invest in your future. These accounts carry special tax benefits and are available to the majority of savers, even if you’re not working for an employer that offers a 401(k) or another retirement account.
But as you’re preparing to open an IRA of your own, you’ll soon be faced with a decision: traditional or Roth? Although these two accounts have many things in common, they have some important differences too.
A traditional IRA allows you to make tax-deductible contributions, easing your tax burden today and helping you grow your funds for the future. It carries a $6,000 contribution limit (2021), but you can open the account no matter how much income you earn.
On the other hand, with a Roth IRA, your contributions are taxable — but they’re allowed to grow tax-free thereafter. Although Roth IRAs have the same $6,000 contribution limit traditional IRAs have, they are subject to income limits. For example, if you’re a single filer, you’re eligible to contribute only if you earn less than $140,000. If you’re married filing jointly, you’re eligible to contribute only if you earn less than $208,000.
Roth IRA benefits: what makes losing out on the deduction worth it?
Although the chance to earn a tax credit today may seem like a no-brainer, there are lots of reasons Roths are advantageous in the long run. Here’s why you should consider selecting the Roth option when opening your IRA.
1. Roth IRAs are flexible
Since you’ve already paid taxes on your Roth contributions, you’re free to withdraw them from the account whenever you want with no further taxes or penalties. However, it’s important to note that you can’t withdraw any gains you’ve made through appreciation.
That means you can use your Roth IRA as a long-term savings account both for retirement and for shorter-term financial goals, such as buying a house or going to college. In fact, the Roth is even more accommodating in those instances because first-time homebuyers and people funding higher education can take distributions, including capital gains, without paying the additional 10% penalty.
2. Roth IRA tax benefits ease the transition to retirement
Although you may earn Social Security benefits or receive checks from an annuity during retirement, these income streams are often taxable.
Roth IRA distributions are tax-free if you’re over the age of 59 and a half and have held the account for five years or more. That can be a welcome break when you’re adjusting to a fixed income for retirement.
3. Roth IRAs let you take full advantage of the power of compound interest
Why is investing so awesome in the first place? Because compound interest can turn even a modest contribution stream into a hefty nest egg.
Since you’ll be taking those distributions tax-free, a Roth IRA lets you take advantage of that growth as much as possible by allowing you to keep more of your capital gains.
4. Roth IRAs don’t carry an age limit
Even children can make Roth IRA contributions, which means you can get your family to start saving up as soon as possible.
You also can name a child as a beneficiary to your Roth IRA, passing down your savings.
5. Roth IRAs offer more favorable benefits for heirs
If you are planning to name a beneficiary to your account rather than taking the distributions yourself, a Roth will offer your heir more tax benefits. She’ll inherit tax-free money rather than the big, fat tax liability she might incur from other types of assets.
Keep in mind, however, that inherited IRAs are subject to required minimum distributions, even if they’re Roths, except when the account is transferred from a spouse.
6. There’s a backdoor Roth IRA option for high-income earners
As mentioned above, income limits do apply to Roth IRAs. If you’re a relatively high earner, you’re ineligible to fund a Roth directly.
However, you can take advantage of the “backdoor Roth” option. You simply open and fund a traditional, nondeductible IRA and then transfer the assets and reap the benefits of the Roth’s unique set of financial advantages.
7. Roth IRAs aren’t subject to required minimum distributions (RMDs)
Most retirement accounts, including traditional IRAs, require you to begin taking distributions once you reach the age of 70 and a half, putting a limit on your saving and earning potential.
Roth IRAs, however, allow you to leave the assets invested as long as you desire, even if that means your entire lifetime.
Roth IRA vs. traditional IRA: which is right for you?
Although Roth IRAs do carry some special benefits you won’t receive with other types of retirement accounts, contributing to a traditional IRA is still an excellent way to save for the future. Although your distributions will be taxable, many individuals expect to be at a lower income tax bracket when they reach retirement anyway. In other words, you might not be subject to as much of a tax liability as you would be for contributing to a Roth today.
Traditional IRAs are available no matter how much income you earn, making them an attractive savings vehicle for high-income earners. No matter which kind of account you choose, one thing’s for certain: Saving for retirement is non-negotiable, and the earlier you start, the better.
The “Find a Financial Advisor” links contained in this article will direct you to webpages devoted to MagnifyMoney Advisor (“MMA”). After completing a brief questionnaire, you will be matched with certain financial advisers who participate in MMA’s referral program, which may or may not include the investment advisers discussed.