It’s not necessarily the ideal retirement account.
401k, IRA: How to choose the best retirement plan for you
There are a variety of retirement savings plans, including traditional IRAs, Roth IRAs, and 401k’s. Here’s how to choose the one that will help you achieve your goals.
Roth IRAs have a reputation as one of the best retirement accounts available, and for good reason. With a Roth IRA, your investments can grow tax-free, and withdrawals at retirement aren’t taxed.
Equally important, Roth IRAs do not force savers to take required minimum distributions (RMDs). This means that if you don’t need it, you can let your money sit and grow for decades after you retire, potentially leaving your heirs with a huge legacy.
But that doesn’t mean a Roth IRA is the right choice for everyone. Here are three reasons why it might not be the best home for your retirement savings.
1. You are currently subject to high taxes
The biggest tradeoff with a Roth IRA is that you pay taxes on your contributions now in exchange for tax-free withdrawals later. This works well if you expect to pay the same or more taxes in retirement.
But if you’re currently in the highest federal tax bracket and expect your taxable income to decrease once you stop working, it may not make sense to pay those taxes now. If you’re a high-income earner, a traditional IRA may be a better fit for you because you can make contributions on a pre-tax basis.
2. I want to do charity work after I retire.
If you are in a strong financial position, you may have plans for philanthropy in retirement. In that case, a traditional IRA may be a better option than a Roth.
Qualified Charitable Distributions (QCDs) allow savers to transfer money directly from a traditional IRA to a qualified charity. These distributions can typically satisfy RMDs while wiping out the associated taxes associated with traditional retirement plan withdrawals.
Technically, you can also do a QCD from a Roth IRA. However, Roth IRAs don’t offer much of an advantage since withdrawals are not taxed. Therefore, if philanthropy is part of your retirement plan, it may be a good idea to pre-pay the tax deduction on your donations so that you can receive further tax deductions when you advance the funds.
3. I don’t trust myself to leave my savings untouched.
Retirement accounts like IRAs typically come with a 10% early withdrawal penalty if you withdraw your funds before age 59 1/2. However, because contributions to a Roth IRA are made with after-tax dollars, you can generally withdraw your contributions (not the earnings portion of your account) at any time without taxes or penalties.
So let’s say you contributed $30,000 to your Roth IRA. Over time, your balance could grow to $100,000. If you withdraw the first $30,000 and keep the $70,000 in gains, you won’t be penalized because you didn’t get a tax break on that $30,000 to begin with.
This flexibility can be helpful if you face a true financial emergency, such as a major home repair that you can’t afford or an extended period of unemployment. But it can also make it easier to drain your retirement savings due to unnecessary expenses. Home renovations, a dream vacation, or a new car may seem more appealing if you know you can access your contributions without penalty.
If you’re worried that easy access will hurt your long-term savings goals, a traditional IRA may be a better option. The threat of a 10% penalty may be enough to force discipline.
Roth IRAs are a great option for many people looking to build retirement savings. But it’s important to realize that it won’t be a perfect fit for everyone. If any of the three points above apply to you, you may want to find another place to store your long-term savings.
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