Is it Better to Have an IRA Or a Roth IRA?
Think of your retirement savings as a snowball rolling down a hill; your choice of an IRA determines its size at the bottom.
No one can predict exactly what their tax rate will be in the future, but Individual Retirement Accounts offer one potential solution: income-tax-free growth. You should first decide between traditional IRAs that provide immediate tax breaks or Roth IRAs which offer delayed tax relief.
Taxes
Traditional IRAs allow you to deduct contributions as they’re made, and when taking distributions in retirement you will pay income taxes on those dollars.
Roth accounts don’t provide tax breaks on contributions, but when withdrawing them you don’t owe any income taxes – this feature could prove especially valuable if your retirement tax bracket will be higher than now.
However, the rules surrounding an inherited Roth IRA can be complex and can require careful attention from its heirs. While withdrawals can often be spread out over multiple lifetimes with certain requirements in place if Congress makes any changes that could change your strategy as well.
Investments
Your investments for an IRA or Roth IRA should have high growth potential; stocks should preferably be included within an IRA while investments that produce taxable income such as municipal bonds and dividend-paying stock funds should remain outside to avoid taxation upon withdrawal.
Consider your future tax situation when selecting retirement accounts. If your taxes are expected to increase in the near future, Roth IRA may make more sense than traditional ones.
Investors can open an IRA online, choosing from an array of mutual and exchange-traded fund options available. Low-cost passively managed funds provide diversification and an established track record; investors should also take their retirement timeline and investing goals into consideration when selecting either an IRA or Roth account type; to do this effectively they may consult a financial advisor in balancing out these benefits, so they can select a portfolio best suited to them.
Withdrawals
Individual Retirement Accounts (IRAs) can be found from numerous financial institutions, including banks, brokerage firms, credit unions and savings and loan associations with IRS approval. Individual taxpayers can open traditional or Roth IRAs while self-employed individuals and small business owners can save using SEP and SIMPLE IRAs.
Withdrawals from an IRA account typically are tax- and penalty-free once they have been open for five years and you are over age 59 1/2. Any earnings withdrawn prior to that age are taxed as income, though exceptions exist for medical expenses, first-time home purchases and disability claims.
Roth IRAs differ from other retirement savings vehicles in that contributions are made using post-tax dollars, so growth in that account will remain tax-free – though you will have to pay income tax on any distributions taken out upon retirement. If your tax bracket will increase during retirement than now, a Roth may be the more suitable choice.
Fees
No matter the type of IRA you select, fees will likely apply. These could include account maintenance charges, investment management costs and trading commissions when you buy and sell securities – fees which could quickly add up and decrease your overall return.
What type of IRA will work best for you depends on your anticipated tax bracket when withdrawing the money; for those in lower tax brackets in retirement, traditional IRAs offer significant tax breaks up front.
If you think your taxes in retirement will be higher than anticipated, a Roth IRA offers tax-free withdrawals for you and your heirs (subject to certain requirements being fulfilled). A Roth IRA also makes up for missed investing opportunities during years when your tax rate was lower.
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