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, December 9, 2020
Roth IRA: Pros
Roth IRAs and Traditional IRAs are similar in that they’re both retirement accounts, but they aren’t the same. Here’s where Roth IRAs shine.
1. Tax-free withdrawals
When you decide to take money out of your Roth IRA, you don’t owe taxes on it because you’ve already paid taxes on the money you’ve contributed. For Traditional IRAs, you pay taxes on the withdrawals. This is helpful to your future self: every time you take money out, you get the full value of it. Traditional IRA owners don’t have that same luxury.
2. No mandatory withdrawals
For Traditional IRAs, you need to start taking money out as soon as you hit 70 and a half years of age. But what if you don’t want to take out money yet? Well, Roth IRAs allow that. There are no mandatory withdrawals for Roth IRAs.
This is a great option if you don’t need to start making withdrawals once you hit a certain age. For example, if you’re still working and earning an income, your money can continue to grow in your Roth IRA account.
3. No maximum age requirements for contributions
For Traditional IRAs, you have a deadline to stop making contributions at 70 and a half years of age. There’s no age limitation for Roth IRAs. You can make maximum contributions as long as you’d like without worry. And when you hit 50 years of age, you can contribute even more through catch-up contributions.
4. You can get a Roth IRA even if you don’t qualify for one
While there are income limitations for Roth IRAs, you can still find a way to get one if you’d like one. A backdoor Roth is when you open a Traditional IRA and later roll it over to a Roth IRA. For high-income earners, this is a great way to tap into Roth IRA benefits even if you can’t initially qualify for one.
5. Limited penalties on early distributions
Because you’ve already paid taxes on your Roth IRA contributions, you can withdraw that money without incurring taxes or penalties at any time. You are still subject to a 10% tax penalty for early withdrawals on your earnings in the account. But if you need the money for an emergency and don’t have any extra savings prepared, you might need to tap into your Roth IRA account.
Roth IRA: Cons
While there are many good qualities of a Roth IRA, here are some ways you might be turned off by them.
1. Tax-deductible contributions
While your withdrawals aren’t taxed, your contributions are. That means every time you contribute to your Roth IRA, you are contributing money that you’ve already paid taxes on. Other retirements accounts handle taxes differently and could be more beneficial to you depending on your tax situation. A 401(k) allows you to contribute money pre-tax and a Traditional IRA allows you to deduct contributions from your taxes.
2. Income limits
Traditional IRAs don’t have income limits — you can earn as much as you’d like and still have one — but Roth IRAs have this barrier.
For the 2021 tax year, if you’re single or filing separately, you’ll need to earn $140,000 or less a year to qualify to make the maximum contributions to a Roth IRA. If you’re filing jointly, you’ll need to make $208,000 or less a year.
Income limitations might hold you back from opening a Roth IRA. If you earn too much, you might want to think about opening another investment account or trying a backdoor Roth.
3. Low contribution limits
While both Traditional and Roth IRAs have the same maximum contribution limitations — $6,000 for 2021 — there are other accounts you can have where you can put more money towards retirement. Keep in mind that the limit applies to your Traditional IRA too if you have one. So if you have both, you can only contribute $6,000 in total across both accounts.
Your employer-sponsored 401(k) plan allows you to contribute up to $19,500 for 2021. This is more than triple what you can give compared to a Roth IRA. If you’re older than 50, you can contribute another $6,500 in catchup contributions without a hitch. And this doesn’t include employer matching, if your company offers it.
If you have a 401(k) plan through work that offers a matching employer contribution, take advantage of the match before contributing to independent investment accounts, like a Roth IRA.
Is a Roth IRA right for you?
While a Roth IRA has some serious benefits, the downsides might be enough for you to look elsewhere. Here are some retirement account alternatives.
- Traditional IRA — If you earn too much to contribute to a Roth or you’d prefer to defer paying taxes on your investment, consider a Traditional IRA.
- 401(k) — If your employer offers one, take advantage of it. The high contribution limit is great if you can afford to max it out. If you’re self-employed, you can try opening a Solo 401(k) or a SEP IRA.
- Roth 401(k) —No income requirements and you can make high contributions like a traditional 401(k) as long as your employer offers it.
Regardless of which one you choose, make sure you settle on the right plan for your financial situation. Your means and retirement goals will determine which one is right for you.