I know thinking about IRA’s isn’t a top priority for most young people, but if you want to set yourself up for long term financial freedom, it’s highly beneficial to start now. The long-term results can be crazy!
When considering saving for retirement, the question is, should you contribute to a Roth IRA or a traditional IRA? While there are some significant differences between the two accounts, making the decision is actually really simple. Join me today, and let’s see which one’s for you.
The Main Difference Between a Roth IRA and a Traditional IRA
The main difference between a Roth IRA and a Traditional IRA is when you will pay taxes on your money. With a Roth IRA, you pay taxes on the money when you earn it and then deposit it into the account. Since you already paid tax on it, you’re then free to withdraw it tax-free in retirement!
With a Traditional IRA on the other hand, you deposit pre-tax money into the account. This means that you’re able to load in cash before you pay taxes on it and allow it to grow ta deferred until retirement. At that point you’ll need to pay taxes and if you weren’t expecting it, you might be hit with a pretty sizable tax bill
Even if you don’t get into the technicalities, just opening an IRA of either type allows you to start amassing significant retirement assets that will grow and work for you for decades.
Taking out Contributions From Your IRA’s
Another key difference between them is when you could take your contributions. For Roth IRA’s, since the deposits are taxed already, the funds are already yours. That means you could take them whenever you want. You don’t have to be 59 and a half, retired, or anything. Most people think that you can’t do that on Roth IRA’s, making them reluctant to try them out. The tax only comes in if you decide to take the additional gains. So for example, you deposit $1000 into your Roth IRA and it grew later to $2500, you could take out that initial $1000 whenever you want! But if you need the other $1500, there would be some tax involved. However, I wouldn’t really suggest getting your contributions (except for emergencies, of course) because you’re going to want your money to grow, right? On the other hand, for traditional IRA’s, it’s merely the opposite. Because the funds haven’t been taxed yet, the government’s not going to let you take that money out without significant penalties.
Watch out for Income Limits!
One of the downsides of Roth IRA’s is that they have an annual income limit of $139K to contribute, while the traditional one doesn’t have any. To simplify that, if you earn more than $139K per year, then you really can’t directly contribute to a Roth IRA. That is if you’re doing it the “normal” way. There are some ways to get around the income limits that I’m currently trying out. So if you’re interested to learn more about Mega Backdoor Roth IRA, you can DM me on Instagram or leave a comment on one of my videos!
What Kind of IRA Is Best for You?
You have to ask the right questions first. (1) Where’s your tax bracket now, and (2) where’s it going to be in retirement? Knowing these two is very significant because if you remember, the main difference between the two is when they’re taxed. If you think you’ll be at a higher tax bracket at retirement, it’s better to choose Roth IRA’s where you’ll be taxed at a lower rate. However, if you think you’re at the peak of your career, your highest income-earning years, and you think it won’t go any higher, consider going for a traditional IRA. You’d want the money to be taxed at the lowest tax rate possible.
If you aren’t able to tell already, I’m pretty biased towards Roth IRA’s. I’m 21 years old, and while you can’t tell where taxes are going in the future, I highly doubt they’re going lower. Also, with all the investing I’ve been doing, I expect to be at a higher tax bracket in retirement. It really makes sense for me to put my money in a Roth IRA.
If you have any questions about IRA’s or personal finance in general, feel free to send me a message on Instagram or leave a comment on this post. I’d love to hear from you as always.