A Roth individual retirement account (IRA) can offer a number of benefits, but it's not always the ideal solution for everyone saving for retirement. In some cases, such as when you need immediate tax benefits, the traditional IRA is a better option. Often, choosing a retirement account comes down to how much you're making now and how much you expect to bring in once you stop working. If you qualify, then picking the right Roth IRA is important. And if you don't, it's time to look at your other retirement account options.
Key Takeaways
- You may not want to open a Roth IRA if you expect your income (and tax rate) to be higher at present and lower in retirement.
- A traditional IRA allows you to devote less income now to making the maximum contribution to the account, giving you more available cash.
- A Roth IRA or 401(k) makes the most sense if you're confident of having a higher income in retirement than you do now.
- If predicting your future tax status is difficult, you can contributing to both a traditional and a Roth account in the same year.
Roth IRAs vs. Traditional IRAs
Both traditional IRAs and Roth IRAs offer distinct tax advantages for those squirreling away money for retirement. However, each works a little differently.
With a traditional IRA or 401(k), you invest with pretax dollars (your contributions are deductible from taxable income) and pay income tax when you take money out in retirement. That means you pay tax on both the original investments and on what they earned.
With a Roth, you invest money that's already been taxed at your ordinary rate and withdraw it—and its earnings—tax-free in retirement whenever you want, provided you've had the account for at least five years.
Another benefit of a Roth is that you can withdraw the amount you contributed (though not your earnings) at any time—even before you retire—tax-free and penalty-free.
In choosing between Roth and traditional IRAs, the key issue is estimate whether your income tax rate will be greater or lesser than at present once you start tapping the account's funds.
If you're opening the Roth late in life, be sure you'll be able to have it for five years before starting to take distributions in order to reap the tax benefits.
Advantages of Roth IRAs
For younger workers who have yet to realize their earning potential, Roth accounts have a definite edge. That's because when you first enter the workforce, it's quite possible that your effective tax rate, expressed as a percentage, will be on the low end. Your salary will likely increase over the years, resulting in greater income—and quite possibly a higher tax bracket—in retirement. Consequently, there's an incentive to front-load your tax burden.
"We advise younger workers to go with the Roth because time is on their side," says financial advisor BrockWilliamson, a certified financial planner withPromontory Financial Planning in Farmington, Utah. "Growth and compounding are one of the beautiful truths about investing, especially when the growth and compounding are tax-free in the Roth."
If you're young, your earnings have more time to compound, and with a Roth, you will owe zero taxes on all that money when you withdraw it at retirement. With a traditional IRA, you'll pay taxes on those earnings.
On the other hand, if you choose a traditional IRA or 401(k), you have to divert less of your income to retirement in order to make the same monthly contributions to the account. That's because contributions are tax deductible. The Roth essentially requires you to pay upfront both the contribution and the taxes on it.
Roth IRA vs. Basic Investment Account
Now let's say that after making the maximum contribution to your traditional retirement account, you then invest all or part of the tax you saved into a regular (non-retirement) investment account—and compare that with investing in a Roth.
Those non-retirement investments will not only be using post-tax dollars, but you'll also be taxed on their earnings once you cash them out at the capital gains rate.
Because of those differences, you might end up paying more tax in the long run than if you put the entire sum you can afford to invest in a Roth account, or as much as the limit allows, in the first place.
When to Not Open a Roth IRA
If you are in your peak earning years, you will be in a higher tax brackets, and your tax rate in retirement will likely be lower. In this case, you may be better off postponing the tax hit by contributing to a traditional retirement account.
If you earn more than the maximum amount, you cannot contribute to a Roth IRA. For 2024, you can't contribute to a Roth if you earn $161,000 or more per year—or $240,000 or more if you are married and file a joint return.
Contributions are also reduced, though not eliminated, at lower incomes. For 2024, they begin at $146,000 for single filers and $230,000 for couples filing jointly.
If your income is relatively low, a traditional IRA or 401(k) may let you get more plan contributions back as a saver's tax credit than you’ll save with a Roth.
Impact of Savor's Credit
A traditional IRA or 401(k) can result in a lower adjusted gross income (AGI) because your pretax contributions are deducted from that figure, whereas after-tax contributions to a Roth are not. If you have a relatively modest income, that lower AGI can help you maximize the amount you receive from the saver's tax credit,which is available to eligible taxpayers who contribute to an employer-sponsored retirement plan or a traditional or Roth IRA.
Under the program, the percentage of contributions credited back to your taxes depends on your AGI. As the credit is designed to encourage lower-income workers to contribute more to their retirement plans, the lower the AGI, the higher the percentage credited back to you. For 2024, joint filers with an AGI above $76,500 receive no credit, but those with a lower AGI get between 20% and 50% of their contributions credited back to them.
Consequently, pretax retirement contributions can boost credit by lowering your AGI. That lowering can be especially useful if your AGI is just above a threshold figure that, if met, would deliver a bigger credit to you.
Is a Roth IRA Worth It?
A Roth can take more income out of your hands in the short term because you're forced to contribute in after-tax dollars. With a traditional IRA or 401(k), by contrast, the income required to contribute the same maximum amount to the account would be lower, because the account draws on pretax income.
The amount saved by making a maximum contribution to the account in pretax dollars could instead be used for any number of useful, even vital, purposes—buying a home, creating an emergency fund, taking vacations, and so on. How much you weigh such potential uses will determine whether you should open a Roth IRA account.
Contributing to Both Roth and Traditional
If you're somewhere in the middle of your career, predicting your future tax status might seem difficult. In that case, you can contribute to both a traditional and a Roth account in the same year, thereby hedging your bet. The main stipulation is that your combined contributions for 2024 can't exceed $7,000 annually, or $8,5000 with a catch-up contribution of $1,000 for those age 50 and over.
There can be other advantages to owning both a traditional and a Roth IRA or 401(k), says James B. Twining, a CFP and founder of Financial Plan in Bellingham, Wash. He notes:
In retirement, there may be some 'low tax' years due to large long-term care expenses or other factors. Withdrawals can be taken from the traditional IRA in those years at a very low or even a 0% tax bracket. There may also be some 'high tax' years, due to large capital gains or other issues. In those years the distributions can come from the Roth IRA to prevent 'bracket spiking,' which can occur with large traditional IRA withdrawals if the total taxable income causes the investor to enter a higher graduated tax bracket.
Frequently Asked Questions (FAQs)
What Are Reasons Not to Open a Roth IRA?
If you are not able to leave the earnings on your contributions in a Roth IRA for a sufficient period of time (five years), you will incur penalties for early withdrawal. Your contributions can be withdrawn at any time. Additionally, if your 2024 income is $161,000 or more, Roth IRA contributions from a single filer are not permitted. If you are married and filing jointly, that limit is $240,000. For those who are single, your maximum contribution will be reduced if you earn between $146,000 to $161,000.
What Is the Best Age to Open a Roth IRA?
The earlier you start a Roth IRA, the better. There is no age limit for contributing funds, but there is an age limit for when you can start withdrawals. You must be 59½ years old to start withdrawing the earnings on contributions or you must pay taxes and penalties. Also, to avoid taxes, the funds must be in the account for five years.
When you put money into a Roth IRA, you will be paying taxes on your income before the money goes into the fund. When you take money out, it will only be tax-free if it has been in your Roth IRA for five years and you are 59½ years old.
Can My Spouse Use My Roth IRA?
Your spouse cannot contribute to your IRA, but they can be named as a beneficiary on the account. The funds will then go directly to your named beneficiaries without going through probate. Named beneficiaries must take funds at least one year after your death. If you do not name a beneficiary, your spouse (if they are your primary beneficiary) can opt to inherit your Roth IRA or roll it over to a Roth IRA in their name.
Can a Non-Earning Spouse Open a Roth IRA in Their Own Name?
Yes, if you are married and filing jointly, your spouse may open their own Roth IRA—a spousal IRA—and fund it separately from yours, even if they do not have any earned income. The combined income of both spouses is treated the same way, even if one spouse generates 100% of the income and the other spouse generates 0%.
The Bottom Line
Although the best time to open a Roth IRA is when you are young and have the power of compounding and interest on your side, it can also be a useful vehicle when you are older and would like to fund an account that is not subject to required minimum distribution rules during the life of the participant. The entire account can be saved until it is needed later in retirement without taxes on distributions. If not needed, your heirs can inherit the Roth IRA with tax-free distributions. (There are minimum distributions after the owner dies.)
