What to do? There is a lot of chatter on the internet about which savings vehicle is better: Roth IRA or Traditional IRA? The unhelpful answer is: it depends. Everyone has unique situations that makes it impossible to have one size fits all but there are certainly things you should consider. The more relevant question you should ask yourself is which is better for me?
- Upfront tax deduction
- IRA: the money you put in will initially be taxed but you will get to reduce your income when you file for your taxes
- Taxed on withdrawal
- The amount(s) withdrawn in a given year will be taxed at your ordinary tax rate
- Initially taxed
- Basically, what this means is that your paycheck will first be taxed (Social Security, Medicare, etc.)
- Then, what’s in your net check is what you have left to contribute
- Withdrawals are free from tax
- Since, you already paid taxes on your contributions there is no taxes upon withdrawal (if you do not withdrawal early)
Now that we know the basic differences lets think about different scenarios. First, time horizon. When I say this, I’m talking about your age. Since, there is an initial tax drag on Roth IRAs it takes time to breakeven with all else being equal. Second, where are you in your career? Early on or have you hit your top earnings potential? If you are just starting out and plan to live off of more at retirement then it may make sense to open a Roth IRA. That way you’re paying less in taxes by going from a smaller tax bracket early on in life to a bigger one at retirement. If you are already in a high tax bracket and plan to be there or lower at retirement then it may make sense to contribute to a traditional IRA.
In all honesty, there really isn’t a wrong answer. The fact that you’re thinking about and preparing for retirement is most important.
[photo courtesy of Stuart Miles – FreeDigitalPhotos.net]