We all want to retire eventually. Right? Retiring with a sizable nest egg should be everyone’s goal no matter how much money you make. When trying to decide which retirement account is best for you, it is important to look at several factors.
Your age, time until retirement, and types of accounts available to you are several things you should take into consideration when planning for the golden years. As for the specific retirement account options, there are numerous ways in which you can invest your money. The most popular are Individual Retirement Accounts (IRA).
Roth IRA
The Roth IRA is a very popular method to save for retirement. Established in 1997 and named after Senator William Roth, the Roth IRA is a retirement account that allows you to withdraw your money tax-free once you hit retirement age (59 1/2). This benefit is extremely valuable as your money grows tax-free throughout the life of the account. Because this benefit is so lucrative, there are annual limits on how much money you can contribute to a Roth IRA. For 2016, the annual cap is $5,500 if you are 49 or younger and $6,500 if you are 50 or older. The extra $1,000 for those aged 50 and older is considered a “catch up” contribution. In addition, because this type of account was created to assist the middle class, there are income limits in order for you to be eligible to contribute. In 2016, if your tax filing status is single, then your income can be no more than $117,000 in order to make the full contribution. If your tax filing status is married, your income can be no more than $184,000 in order to make the full contribution. Since the majority of Americans don’t make more than these limits, the Roth IRA is a great way for most people to save for retirement.
Traditional IRA
The traditional IRA was the predecessor to the Roth IRA. Both the traditional and the Roth IRA employ the same annual contribution limits of $5,500 or $6,500 depending on your age. The most significant difference between the two is when it comes to taxes. Unlike the Roth, the traditional IRA does not grow tax free. Contributions are made pre-tax, therefore, taxes must be paid once the money is withdrawn in retirement. Generally speaking, most people see an increase in their tax rates as they grow older. Because of this, it is very likely that you will pay much more in taxes on your money when you are in your 60s or 70s than you would have if you had opened a Roth IRA and paid the taxes before you put the money in the account. Another key difference between a traditional and Roth IRA is the income limits. Unlike the Roth, the traditional IRA does not have any income restrictions you must abide by. Because of this, the traditional IRA is a viable alternative to the Roth if your income exceeds the limits.
Which is best for me?
There’s an easy answer to this. The Roth IRA is a more effective retirement account for the majority of people especially if you are in your 20s or 30s. No matter which side of the political spectrum you fall on, it’s hard to believe that tax rates will be going anywhere but up over the next 3 or 4 decades. My advice would be to pay the taxes on the money now and let your money grow tax free because chances are your tax rate will be much higher once you hit retirement age. If you already have a traditional IRA and wish to roll it over to a Roth IRA, expect to pay taxes on the money at the time of the transaction. Consulting with your tax professional on this is recommended as converting your traditional IRA to a Roth isn’t always the best option depending on your age, tax bracket and size of your nest egg.
I hope this helped shed some light on the differences between a Roth and traditional IRA. If you want more details on either type of account you can head over to the IRS website. It is very helpful. If you have any questions or comments please leave them below. Hope you enjoyed!
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