No matter how much you may be making, setting aside a portion for retirement is always a smart move. But one decision your current income–among other factors–does affect is whether you’re better off saving with a Roth IRA, or a traditional retirement account. Making the right choice means evaluating your present financial status, while also considering what your earnings might look like in the future. Here are a few tips to help clarify your ideal IRA.
Compare Your Current and Estimated Future Income
The Roth IRA does have income limits, although the majority of those just starting to save for retirement aren’t likely to exceed them. There are no income limits for traditional IRAs, however income (and whether an employer provides access to a 401(k) or other retirement accounts) will determine if contributions to a traditional IRA qualify as fully or partially tax deductible.
Consider When You’d like to Pay Taxes
A key distinction between Roth and traditional IRAs is whether taxes on savings are paid as you contribute, or after you start taking money out. Traditional IRA contributions are tax deductible, so your current tax bill will be lower. Roth IRAs contributions aren’t deductible, but earnings accumulate tax-free, while traditional IRs collect taxes upon withdrawal of funds.
If your earnings are high right before you retire, you may move to a lower tax bracket once you stop working. In that case, it could be beneficial to deduct taxes ahead of time via a traditional IRA. If you anticipate being in a record high tax bracket when taking out withdrawals, then a Roth IRA might be best. Those that can’t fathom what their earnings may look like in 30 years might prefer splitting contributions between both IRA types. In all scenarios, total contributions must remain within acceptable limits.
Know the Early Withdrawal Policies of Each Type
Making a withdrawal before age 59 and a half will cost a 10% penalty in many cases, though some exceptions apply. Withdrawal ahead-of-time from a traditional IRA, however, and you’ll pay taxes at your present rate. Early withdrawals from Roth IRAs are tax free, so long as your first withdrawal comes at least five years after the initial contribution. Money taken out before the five year-mark may be taxed, or penalized 10% depending on the circumstances of the withdrawal.
Look into Required Minimum Distributions
Turning 70 means that those with traditional IRAs will have to take required minimum distributions. This could be detrimental to any who aren’t already living off of their retirement savings, as mandatory withdrawals will limit or prevent the account from growing further. In addition, owners older than 70 and a half can no longer make contributions to traditional IRAs.
Roth IRAs don’t have any rules mandating a minimum distribution (as long as they aren’t inherited). Savings are free to appreciate throughout the entirety of a Roth IRA owner’s life, and contributions still can be made over the age of 70 and a half.