The Rule of Thumb for the Roth IRA
One of the most commonly asked questions among investors is whether to choose a traditional or a Roth IRA. There are two distinct choices of Individual Retirement Account IRA) – the traditional, or taxable, IRA and the Roth IRA, whose proceeds are tax free when withdrawn in retirement.
The traditional and Roth IRA also differ in how their taxes are handled when the contributions are first made. The contributions made to a traditional IRA are tax deductible, subject to income and other eligibility requirements, but the contributions made to a Roth IRA are not tax deductible. This is the tradeoff for tax free treatment when the proceeds are withdrawn.
In most cases it will be preferable to opt for a Roth IRA if you expect to be eligible for these tax free distributions. It is important to remember that the funds must remain in the IRA until the worker is 59½. Those who expect to withdraw their IRA funds before 59½ may be best opting for a taxable IRA account.
For those in a low tax bracket during their working years, a Roth IRA is generally the better choice, while those in a higher tax bracket may benefit from the tax deductibility of a traditional IRA.
Those who are covered by an employer sponsored pension or 401(k) plan do not have to make a choice. Workers are allowed to contribute to both a 401(k) and an IRA.
Those who do not have sufficient funds available to fully fund both an IRA and a 401(k) will need to decide which option provides the greatest benefit. In general it is important to contribute at least enough to your employer’s 401(k) to get the maximum company match. After that goal is achieved it is important to determine whether further contributions to a 401(k) or contributions to a Roth IRA are the best move. A financial planner or certified public accountant can help with this important decision.