When it comes to managing your retirement savings, the choices you make now might seem inconsequential, but they can (and probably will) have some major ramifications down the road. Whether you’re just launching a retirement savings plan or you’re at a crossroads trying to decide where to put your money moving forward, here’s the basic information you need to know to decide between two of the top contenders: a Roth vs. traditional IRA.
Don’t worry—it’s not as intimidating as it seems.
What Is a Roth vs. Traditional IRA?
When it comes to deciding between a Roth vs. traditional IRA, there are a few key places where they differ according to RothIRA.com:
- Restrictions. Anyone who is younger than 70.5 years old can contribute to a traditional IRA. Whether or not these contributions are tax deductible depends both on income and whether or not the contributor or their potential spouse already have a retirement plan (such as a 401k) in place. Roth IRAs, on the other hand, don’t have age restrictions, but they do have income restrictions—you can’t contribute to a Roth IRA if your adjusted gross income is $135,000 or over. Married couples who file jointly must make less than $199,000 to contribute.
- The timing of tax breaks. Contributions to Roth IRAs are taxed when they’re deposited but not when they come out. The opposite is true for traditional IRAs—there’s no taxation on contributions, but when you withdraw down the line you’ll be taxed at whatever rate your income tax is at that time. If you think you’ll be in a higher tax bracket when you take your money out than you are when you deposit the money, a Roth IRA might be the choice for you. However, if you can’t afford the taxes now and think the burden could be lesser in the future, you might want to go the traditional IRA route.
- When you can withdraw. Once you reach 70.5 years old you’re required to start withdrawing from a traditional IRA. Roth IRAs don’t require any withdrawals ever, which makes them ideal candidates for wealth transfers. Both Roth and traditional IRAS allow distributions starting at age 59.5, but Roths require that the first contribution was made five years or more before the first withdrawal, so if you start a Roth late, you won’t be able to withdraw until later. It’s important to note that you can withdraw your contributions from a Roth at any time, it’s just the earnings from the interest that are subject to withdrawal rules.
Many economists believe federal income tax rates will rise in the future—meaning Roth IRAs may be the better long term choice.
Which Is Better: A Traditional or Roth IRA?
Whether or not a Roth IRA or a traditional IRA is better depends entirely on your current and future financial situation and what financial wellness means to you. There are, of course, a variety of highly personalized factors to weigh, plus there’s the uncertainty of what both federal and state tax laws will be decades from now. However, as RothIRA.com notes, “given today’s historically low federal income tax rates and the large U.S. deficit, many economists believe federal income tax rates will rise in the future—meaning Roth IRAs may be the better long term choice. But of course, no one knows.”
Is It Good to Have Both a Traditional and Roth IRA?
Similarly, the decision to have both a traditional and a Roth IRA is highly individualized, but it’s certainly possible to have, and contribute to, both at the same time. As the Balance explains it, “provided you meet the earned income requirements and the income limitations for each type of IRA, you man contribute to both a Roth and a traditional IRA. In fact, many savvy investors who are qualified to make contributions to both types of IRAs do so in order to reap the immediate benefits of tax-deductible contributions and the long-term benefits of tax-deferred and tax-free future income.”