Is Roth or Traditional the best way to go? – The fool

If you are starting your first job or are still relatively young, starting to save for retirement or increasing your retirement savings may be the smartest financial decision you can make. The long-term compound power you have can turn seemingly modest amounts into a big nest egg on the road.

One of the best ways to invest for retirement is to go through an IRA, but there are two types: traditional and Roth. Here is a quick guide that can help beginners determine the most suitable IRA variety.

Source of the image: Getty Images.

What is an IRA and why should you use one?

An IRA, which means "individual retirement arrangement (or Account), "is a tax-based savings vehicle designed to help Americans save and invest money for retirement.The IRAs come in two varieties – traditional and Roth – and will be discussed later.

With one or the other type of IRA, eligible savers can pay a maximum of $ 5,500 for 2018 ($ 6,500 if age 50 or over). Once the money is paid, it can be invested in stocks, bonds, mutual funds, ETFs and many other options. If you wish, you can also leave it in cash or equivalent. And you may be able to invest in an IRA in addition to an employer retirement plan such as a 401 (k).

Generally, you can not retire from the IRA before the age of 59 and a half, but there are some exceptions. For example, there is a great exception of Roth IRA early withdrawal in which I will look during the discussion on Roth, and IRA funds can be used early for college expenses or for a first purchase ( up to $ 10,000) without penalty. .

Until now, the main advantage is that the beneficial nature of the IRAs in terms of taxation can allow you to build up a much larger pension wealth than if you were investing in a standard (taxable) brokerage account. Now, let's get into the differences between traditional IRAs and Roth.

Benefits of a traditional IRA

The main difference between traditional IRAs and Roth is their respective tax treatment, so let's start with the traditional IRA.

Traditional contributions to the IRA are usually granted with a tax deferral. This means that the money you invest may be eligible for a tax deduction for the current year and that it can grow and be compounded with no tax on dividends or capital gains, while the funds remain in the account. When you withdraw money from your traditional IRA, however, it will be considered taxable income. In short, a traditional IRA can give you a great tax advantage now.

It is also important to point out that I said that you "could" be eligible for a tax deduction. Everybody can to contribute to a traditional IRA, but the opportunity to take advantage of the tax deduction is limited by income. If you have access to a workplace retirement plan, here are the 2018 income limits for the traditional IRA deduction:

Data source: IRS.

On the other hand, if you do not have a retirement plan at work, your ability to take the deduction is limited only if your spouse has an available retirement plan at work. In this case, the income thresholds are as follows:

Data source: IRS.

Roth IRAs have unique benefits

Unlike a traditional IRA, Roth IRA contributions are never tax deductible. However, the money in the account can increase and add to the tax on dividends and capital gains, and qualifying withdrawals will be tax-free at 100%. So, while a traditional IRA gives you an immediate tax advantage, a Roth IRA allows you to pay taxes now with the goal of creating a source of tax-free income later in life.

In addition to the tax benefits, there are some other advantages to investing with a Roth IRA that does not apply to traditional IRAs.

First of all, since you have already paid taxes on the money you contribute, you can withdraw your contributions (but not your investment income) at any time and for any reason, without paying an early withdrawal penalty to the IRS. In addition, there is no maximum age to contribute to a Roth IRA, nor is there a minimum need for distribution once you reach a certain age.

The ability to contribute directly to a Roth IRA is limited by income. For 2018, your income must comply with these limitations in order to invest in a Roth IRA:

Data source: IRS.

If you do not meet the income criteria, you may be able to contribute via the backdoor method. Essentially, it means contributing to a traditional IRA and immediately converting the account to a Roth.

What is the best for you?

The best choice for you depends on your personal situation. From a purely fiscal point of view, a traditional IRA makes more sense for a person whose income is relatively high and who is likely to be in a lower tax bracket after retirement. On the other hand, a Roth IRA makes more sense for savers whose income is relatively low and who will not pay much tax on their contributions.

As a personal example, I used a Roth IRA for a few years after college, while I was a new high school teacher, but while my income was starting to increase a little, I went to the traditional way.

That being said, some of the benefits of a Roth IRA need to be taken into account, particularly the ability to withdraw contributions at any time. If your least favorite thing about retirement savings is to keep your money for decades, a Roth could be the best choice.

As I said, it all depends on your level of income and your personal preferences. As long as you qualify for the tax benefits of each, you will not go wrong with any of these options, but by assessing the benefits of each, you will be able to make the best choice for you (and for your future).