Is it Better to Have an IRA Or a Roth IRA?
IRAs can be valuable retirement savings tools, offering tax-deferred or tax-free growth potential. Deciding between traditional or Roth IRAs depends on your family’s tax situation, timeline for investing and anticipated income during retirement.
Roth IRAs may make sense if you anticipate being in a higher tax bracket in the future; otherwise, traditional IRAs could provide tax breaks now by deducting contributions made now.
Taxes
As with most investment decisions, selecting either a traditional or Roth IRA depends on your current tax status and anticipated tax bracket in retirement. Those expecting to fall into lower tax brackets during their retirement should look into Roth IRAs instead, which allow withdrawals without incurring tax liabilities compared with required minimum distributions in employer-sponsored accounts such as 401(k).
Traditional IRAs are tax-deductible accounts that allow you to take a deduction on money you put into them; the investments in them grow tax deferred – you won’t pay taxes until withdrawing them in retirement.
Roth IRAs differ in that you won’t get a tax deduction on contributions, yet all investment earnings grow tax-free. There is one caveat, however: To withdraw funds before turning five years old (known as the five-year rule). Though this delay might help increase savings for retirement.
Withdrawals
Withdrawals from traditional IRAs may put you into higher tax brackets; however, with Roth withdrawals you have more leeway. By switching up how and when you take money out, Roth withdrawals allow for more maneuverability in making sure you avoid reaching your highest income tax bracket in retirement.
However, you still owe taxes when withdrawing funds from a traditional IRA; and it’s impossible to predict your tax rate several years ahead. Without careful management of distributions, more taxes than necessary may be withheld from savings over time and your savings might even decrease further than they could otherwise be.
When using your IRA funds for emergencies or early withdrawals, they’ll be taxed as taxable income and subject to a 10 percent penalty. Furthermore, it is necessary to keep track of the amounts you withdraw; in particular the IRS requires Roth IRA owners to file Form 8606 when reporting distributions – this document can be found under “Reports” on your account statement.
Investments
As with 401(k)-style retirement accounts, IRAs provide tax-advantaged investments. Contributions made with pre-tax dollars grow tax deferred while Roth withdrawals typically become tax free after reaching certain age. Withdrawals prior to that may be subject to an additional 10 percent penalty unless used for medical bills, unemployment hardship or homebuying purposes.
Investors looking for long-term investment returns should create a portfolio composed of both growth and income stocks and bond funds to achieve optimal long-term returns. When selecting funds, take cost into consideration as investing in lower cost mutual funds or ETFs can reduce expenses while improving returns. Traditional IRAs require retirees to start taking required minimum distributions at certain ages while Roth IRAs do not. A Roth can therefore be more appealing for people expecting to face higher tax brackets in retirement while for most others an upfront tax break makes the traditional IRA the more appealing.
Fees
As with any investment account, an IRA incurs fees. While fees can reduce returns over time, it’s still wise to be informed and compare your options before settling on one.
As part of your IRA fees, you’ll pay management fees to the companies that manage your funds as well as expense ratios on mutual funds held within it. Custodial fees may also apply when holding alternative assets like real estate and precious metals.
One factor to take into account when investing in an IRA for retirement is your tax situation in retirement. If you anticipate being in a higher tax bracket upon retiring than now, a traditional IRA might make more sense; withdrawals would still be taxed at your current rate but the up-front tax break might help mitigate that effect. A Roth IRA doesn’t provide this same advantage but allows contributions to be withdrawn tax free in retirement which could provide peace of mind if future tax situations concern you.
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