We’ve talked about making the call between a 401k vs a Roth IRA retirement account, but what if we add an extra decision to your plate by telling you that you can also choose between a Roth versus Traditional IRA?
Don’t panic! We’re throwing more information at you, yes, but an informed girl is a savvy girl and that’s the goal here.
Instead of letting you get overwhelmed by choice, we’re giving you the deets about allllll of your options so that you can make an educated decision. We know — we rock.
Once Again, It All Comes Down to Taxes
We’ve said it before and we’ll say it again: most of your big financial decisions come down to when you pay taxes.
There’s no way to avoid taxes forever, but you do get to choose when you pay them. We’ll take what we can get, I guess.
The biggest difference between a Roth versus Traditional IRA is when you get to take advantage of your tax break.
Contributions to traditional IRAs are tax-deductible, but you’ll pay taxes later when you make withdrawals.
On the flip side of that situation, you’ll pay taxes on your contributions to a Roth IRA, but your withdrawals during retirement (you know, when you actually need the money) are tax-free.
Unless you are clairvoyant, it’s impossible to know what your tax rate will be in the future. But, you know what is possible to know? The current tax rate. And, right now, tax rates are historically low.
That’s why we believe there’s a clear winner here in the form of the Roth IRA. Why play tax roulette by deferring taxes until retirement when your rate is much less certain?
You have a defined tax rate right now and no way to know what your tax rate will be in the future, so get the taxes part out of the way now. This will allow you to maximize your available income during retirement.
If you’re still unsure, there are a few other factors to consider that can help make your decision.
Rules, Rules, Rules
Let’s talk about withdrawals first. AKA, actually GETTING your money!
Although early withdrawals are generally frowned upon, you’ve got much more flexibility with a Roth than a Traditional.
A Roth IRA allows you to withdraw contributions (the money you put into the account, not the earnings) without having to pay income taxes or an early withdrawal penalty.
If you try to do the same with a Traditional IRA, you’re likely to pay a 10% penalty and owe taxes at your current rate on the money you take out.
2) Required Minimum Distributions
Next, RMDs. If you’ve forgotten or you’re new here (greetings!!!), a required minimum distribution is a way for the government to MAKE you start using your retirement money.
Traditional IRAs require you to start taking out minimum distributions at age 72.
Can you believe?? You make it all the way to retirement, saving money along the way like the badass you are, and then the government has the audacity to tell you when and how you use it. Um, no thanks.
With a Roth IRA, you’re free to let those savings stay put and continue to grow (tax-free, baby!) as long as you live. This is yet another A+ in our book, as this makes the Roth IRA a great way to pass money on to your beneficiaries, if you so choose.
3) Income Requirements
Finally, it’s important to talk about who is eligible for each type of retirement plan based on income.
Absolutely anyone with earned income can contribute to a Traditional IRA.
Roth IRAs, on the other hand, have income-eligibility restrictions. So, if you’re a high earner (in 2021, this means an individual making more than $140,000), you might be exempt from contributing to a Roth IRA.
If that’s the case, great! Your decision has been made for you.
The Bottom Line
In short, Traditional IRAs function a little like a pension — in return for tax breaks, you are susceptible to certain restrictions and the government has a say in how and when you access your funds.
A Roth IRA functions more like an investment account with tax benefits — you still get a tax break but with fewer restrictions and more flexibility.
The choice is up to you, but we believe the Roth IRA offers a lot more freedom of choice, while also allowing you to plan ahead.
If we’ve done such a good job convincing you that you’re regretting your choice of a Traditional IRA… we have good news. In most cases you can convert a traditional IRA to a Roth, allowing you to take further control of your retirement plan without losing your progress so far.
Additionally, some companies now offer a Roth 401k, making your life that much easier! Ask Nancy in HR about your company’s specific offerings to get started!
No matter what, you deserve to be in complete control of your financial future. Choosing a plan that will maximize your retirement income ensures that your hard work now pays off in the form of a carefree retirement later.