If you’re the average person, you are probably aware of the significance of getting your financial house in order for retirement. The federal government makes it possible for individuals and spouses, to create retirement savings accounts with certain options for paying taxes. These options are the basis for the main difference between a Roth IRA vs Tradition IRA.
Contributions to a Roth are made by way of earnings which have already been taxed. Contributions to a traditional IRA are deferred until the account owner reaches retirement age and begins pulling out their funds. It is at this point that income taxes are levied against BOTH contributions and profits.
But given these facts, how is it possible to which type of IRA presents the best option?
Okay, the truth is, there is no way to be absolutely sure…that is until the time you retire and you can look back at your decision.
The closest you can come to making a good decision is to look at the tax bracket you fit into at the time of the IRA creation and make an educated guess about what tax bracket you will be in at retirement.
If you believe you are likely to be in the same or even lower tax bracket retirement time, then a Roth IRA will be the more sensible choice. But if you think your future tax bracket will ultimately be lower than your current tax bracket, a traditional IRA will be the more suitable alternative.
Something else to consider when trying to make the choice between a Roth IRA vs traditional IRA is your age and what stage you are at in your career.
Younger people, in early stages of their occupations, can safely assume their income will increase as time passes. In this situation, a Roth IRA may perhaps be a smarter alternative.
Furthermore, young people who are getting started in their adult lives may find themselves needing to take advantage of the ability to withdraw contributions, anytime, from a Roth IRA, without having to worry about being taxed or penalized. This withdrawal benefit is not available with a traditional retirement savings plan.
So let me give you an example of how this might work.
Let’s imagine you’re employed for an organization which offers their workers participation in a Roth 401k plan. As a participant, you come up with a $10,000 contribution for this account and then soon after decide to roll this sum over into Roth IRA. To this contribution you add another $5,000.
Now let’s just suppose your $15,000 Roth account makes $5,000 because of some smart investments. Your retirement savings account is now valued at $20,000.
Should you experience some unexpected expenses, you would be able to take out the entire $15,000 contribution with no penalty and taxes. Now, you could also take out your $5,000 earnings, however, but you need to know you would definitely be forced to shell out applicable income tax and also a penalty of ten percent.
But the story doesn’t end here. If you make consistent contributions to your employer’s 401(k) plan, and your earnings continue to go up over the ensuing years, you could decide to split up your contributions rollover, fifty-fifty, between Roth IRA vs traditional IRA.
The bottom line is that making the choice between a Roth IRA vs traditional IRA takes some information, a little guesswork, and consistent contributions in order to hedge your bets on any income bracket you may find yourself in at retirement.