Which type of IRA should I invest in?
3 min read
Are you confused about which type of IRA to invest in?
Here’s the easy answer: First, invest in a Roth IRA, then into the Traditional IRA.
Read on to learn more.
If you are planning to save for retirement, you may have heard of two types of individual retirement accounts (IRAs):
- Roth IRA and
- Traditional IRA.
Both offer tax advantages, but they differ in how and when they do so. In this blog post, we will explain the main differences between a Roth IRA and a Traditional IRA and help you decide which one may be better for your situation.
A Roth IRA is a type of IRA that allows you to contribute after-tax dollars to a retirement account. You pay taxes on the money you put in but not the money you take out. Enjoy tax-free growth and withdrawals if you follow the rules.
A Traditional IRA is a type of IRA that allows you to contribute pre-tax dollars to a retirement account. This means you get a tax deduction on the money you put in, but you pay taxes on the money you take out in retirement. The benefit of a Traditional IRA is that you can lower your taxable income in the year you make the contribution and pay lower taxes in retirement if your tax rate is lower than when you were working.
One of the main factors to consider when choosing between a Roth IRA and a Traditional IRA is
Your current and future tax situation: If you expect your tax rate to be higher in retirement than it is now, you may benefit from a Roth IRA. If you expect your retirement tax rate to be lower than now, you may benefit from a Traditional IRA. However, there are other factors to consider, such as your income level, eligibility for other retirement plans, and your personal preferences.
Contribution limits and rules for each type of IRA: For 2023, the maximum amount you can contribute to either a Roth IRA or a Traditional IRA is $6,500 per year ($7,500 if you are 50 or older). However, income limits may affect your ability to contribute to a Roth IRA or deduct your contributions to a Traditional IRA.
For example, suppose you are single and your modified adjusted gross income (MAGI) exceeds $144,000 in 2023. In that case, you cannot contribute to a Roth IRA. If you are married and filing jointly and your MAGI is more than $214,000 in 2023, you cannot contribute to a Roth IRA either. On the other hand, if you or your spouse are covered by a retirement plan at work, such as a 401(k), your ability to deduct your contributions to a Traditional IRA may be reduced or eliminated depending on your income level.
- Withdrawal rules for each type of IRA: You cannot withdraw money from either a Roth IRA or a Traditional IRA before age 59½ without paying a 10% penalty and income taxes on the amount withdrawn (unless you qualify for an exception). However, there are some differences between the two types of IRAs regarding withdrawals.
For example, with a Roth IRA, you can withdraw your contributions without penalty or tax, but not your earnings. With a Traditional IRA, you must start taking required minimum distributions (RMDs) at age 72 (or 70½ if you were born before July 1, 1949), regardless of whether you need the money. With a Roth IRA, there are no RMDs during your lifetime.
There are pros and cons to both types of IRAs. The best choice for you depends on your circumstances and goals. Our mentors can provide personalized advice and answer questions about Roth IRAs, Traditional IRAs, and other retirement accounts. With our Mentors, you can feel confident in your retirement planning decisions. Get started with a free account today!