When you’re steeped in debt, paying it down may be your sole focus. How do I pay it off? Should I pursue a debt consolidation loan? Seeking to have my debt settled or forgiven? Will I ever be debt-free? Nonetheless, there are other financial planning tactics you can – and should – consider. In particular, selecting a retirement account is one of the toughest choices you will make when it comes to planning for your future.
The two primary types of IRAs, or traditional retirement savings accounts, are the traditional IRA and the Roth IRA. While both carry certain advantages and disadvantages, they serve an important role in your overall retirement planning.
Here, we discuss the key differences between the two types of IRAs, as well as a few considerations to weigh in determining which is best for you.
The Traditional IRA v. the Roth IRA: Key Differences
The biggest difference between a traditional IRA and a Roth IRA is how the accounts are taxed. Traditional IRAs offer an up-front tax deduction on contributions. As a result, retirement savers see immediate tax savings in the year in which they make their contributions. On the other hand, a Roth IRA does not offer an up-front tax deduction, forcing savers to use post-tax money to make their contributions.
In retirement, though, these benefits are reversed: Roth IRA withdrawals are generally tax-free, whereas withdrawals from traditional IRAs are taxed.
Which is Best for You? Key Considerations
In considering which IRA option is best for you, there are certain factors you should consider.
First and foremost, do you want to take withdrawals in retirement? Traditional IRAs require most savers to take withdrawals as soon as they reach a certain age, and the amount of those withdrawals is based on life expectancy. If you do not take these withdrawals, you will owe a penalty tax of up to 50% of the amount you should have taken. Roth IRAs do not carry this requirement and as such, allow savers to keep their money in the accounts indefinitely.
Second, consider whether your income precludes you from having a Roth IRA. There are certain income limits above which you cannot contribute to a Roth IRA. On the other hand, there are no income requirements for a traditional IRA. Speak with your accountant or tax preparer to see whether your income bars you from contributing to a Roth IRA.
Making a Smart Decision
Ultimately, the key to a smart retirement savings strategy is to reduce your tax requirements as much as possible. If you are in a low tax bracket, consider how a Roth IRA can help you keep more of your funds. Conversely, if you are in a high bracket, you may benefit from taking a deduction now and as such, may want to consider a traditional IRA.
Both types of IRAs are powerful tools that can help you prepare wisely for financial freedom. If you need assistance determining which option is best for you, reach out to your accountant or tax preparer to discuss the pros and cons of each.