Are you trying to compare a Roth IRA vs Traditional IRA so you can decide which is best for you? The decision can be complicated, as both retirement accounts offer unique benefits.
It’s important to understand the details of each account before deciding which is best for your individual financial situation. In this blog post we will explore the differences between a Roth and Traditional IRA so you can make an informed decision about which one is right for you!
We’ll look at their respective overviews, compare them side by side and discuss tradeoffs in order to give you all the information necessary when making your choice on roth ira vs traditional ira.
Roth IRA Overview
What is a Roth IRA?
A Roth IRA is an individual retirement account (IRA) that allows you to save for retirement with after-tax dollars. This means that contributions are made with money already taxed, and withdrawals in retirement are tax-free. The main benefit of a Roth IRA is the ability to withdraw funds without having to pay taxes on them.
That is what you need to know for this article. Learn more details about Roth IRAs here.
Often times advisors will say to always contribute to a Roth IRA. However, you may not be eligible. If that is the case, then you should look into a backdoor Roth IRA.
Traditional IRA Overview
What is a Traditional IRA?
A Traditional IRA (Individual Retirement Account) is an investment account that allows individuals to save for retirement on a tax-deferred basis. Contributions are made with pre-tax dollars, and any earnings grow tax-free until withdrawn in retirement. Withdrawals from the account are taxed as ordinary income in retirement.
Roth IRA vs Traditional IRA Summarized
For our purposes, you only need to know three main points when deciding between a Roth IRA and a Traditional IRA.
Funding: Traditional IRAs are funded with pre-tax dollars today so you get to pay less taxes today if you use one relative to a Roth IRA.
Withdrawls: When you take money out of an Traditional IRA after 59.5 you are taxed. With a Roth IRA, the withdraws are tax free.
Penalties: If you take money out of a Traditional IRA before 59.5 you pay taxes AND you are penalized. On a Roth IRA, you can withdraw contributions whenever you want to and you are not penalized.
Why Main Stream Advice Is Wrong
There tends to be two schools of thought when deciding to use a Roth IRA vs a Traditional IRA…. and they are both wrong.
Always invest in a Traditional IRA
Some always say to invest in a Traditional IRA because of the tax deduction you receive. However, if you are already in a low tax bracket this advice makes little to now since.
Always Choose A Roth IRA
There is another camp of “financial professionals” that say to always use a Roth IRA (Or Roth 401k) no matter what. Their reasoning is the fiscal problem we have in this country.
Their point of view is the only way to pay off our debt is to increase taxes. Therefore, shelter as much money as you can from the tax man.
Nobody can predict tax laws. Therefore, you have to base you choice on what you know today. Then do what you can to minimize various risks of the future. I discuss this more below.
When To Use A Roth IRA vs A Traditional IRA
Nothing is ever cut and dry. However, below are rules of thumbs that typically result in the most money over time.
You Have A 401k/403b
If your employer offers a 401k, 403b or any other pre-tax type of retirement account, then you’ll want to put some money in that. Most likely you’ll be putting enough in to get your match.
From there the choice is easy. Put at least $50 a month into a Roth IRA.
You put money in both for retirement income diversification. The reason is you can’t predict the future of taxes. Having both helps minimize the risk of tax laws changing and hurting you in the future.
If you have more money after you do your match and $50 into a Roth IRA, then you have to run a simulation to see what would give you more in the long run.
For example, I ran a simulation for a FitBUX member earlier today using our financial planning technology and maximizing her Roth IRA contribution gave her way more usable money throughout retirement.
Your Employer Doesn’t Offer A Retirement Account
Below a certain income threshold Roth IRAs are almost always better. Above a certain threshold Traditional IRAs are better.
Then there is this gap over about 15k where you could go either way. However, if you fall into that gap, a Roth IRA is probably better because of the additional benefits you receive in them.
What these income thresholds are depends on your personal situation. This customization is one reason why FitBUX includes a Roth IRA vs Traditional IRA analysis in our financial planning technology.
When To Definitely Not Use A Roth IRA
I’ve heard a lot of financial planners tell people when they leave their employer to always rollover their 401k to a Roth IRA. These are the same people that fall into the aforementioned “always invest into a Roth IRA” camp I mentioned above.
This could be good advice if you are in a low tax bracket. However, if you are in a high tax bracket, the benefit of this is greatly diminished often times so much so it makes absolutely no since to do.
In conclusion, when it comes to Roth IRA vs Traditional IRA, there are many tradeoffs to consider. Both have their advantages and disadvantages that should be weighed carefully before making a decision.
Ultimately, the best option for you will depend on your individual financial situation and goals.
This decision can end up being very complex based on your situation. We’ve helped thousands of people make the decision using our technology and FitBUX Coaches.
We’d love to help you to. Therefore, if you’d like help be sure to sign up and become a member of FitBUX.