Roth and traditional IRAs are both savings accounts that are geared towards a person’s eventual retirement. They are similar to a 401K with which a company would set you up, the difference being that you’re the one who is setting up the account and you’re putting money into it according to a schedule that you set, rather than every week as is traditional with a 401K. You might set up a self directed IRA today if it’s something that interests you, but before you dive in, let’s take a few moments to talk about the difference between the traditional IRA and the Roth version that is also popular.
When and How Your Money is Taxed
The most notable differences between Roth and traditional IRAs have to do with how and when the government taxes you on the money that you are putting in. Uncle Sam is always going to have a handout. That much is unavoidable, but with a traditional IRA, your contributions are tax deductible in the year that they were made. If you get a Roth IRA, then your withdrawals are not taxed when you make it to retirement.
Think About the Tax Rate
In determining which one you should be getting, the most critical question that you should be asking yourself is whether you think that your tax rate is going to be lower or higher in the future when you want to cash out. Few people can answer that question definitively, but for the ones who can, the choice becomes easier. If your tax rate is going to be higher, then you’re going to want to get the Roth IRA because of the deferred tax benefit. If it is going to be lower, then it’s got to be the traditional IRA because with that you get the tax benefit up front.
The problem with this approach, of course, is that most people have no idea what their tax rate is going to be when they retire, as most of them start up an IRA when they are decades away from getting out of the workforce.
Many people decide to go with a Roth, though, and the reason is that there are much more flexible rules that go along with one, especially as it relates to early withdrawals. Ideally, you don’t want to take any money out of your IRA until you hit 59 ½, which is when most people are eligible to dip into that money without penalties. Sometimes the unexpected happens, though, and you need money for things like buying a home. The Roth also has rules in place that make it easier for you to pass money on to your heirs if that’s what you decide that you want to do with some of it.
Which Will You Choose?
Several considerations are going to have to go into your decision, and if you think that now’s the time to start up an IRA, you may wish to consult with a retirement expert at your bank. They should be able to explain any further details about the Roth and traditional IRA versions to you, and together you can pick the one that makes the most sense for your needs.
For more business advice from the Be a money blogger blog, click here.