Because Social Security won't provide enough income for you to pay your bills in retirement, you'll need to save independently for a shot at financial security in the future. But not all retirement plans are created equal, and if you're thinking of going the IRA route, you may be wondering whether it pays to save in a traditional account versus a Roth.
Of course, both account types are beneficial in their own right -- but there are several aspects of the Roth that make it the superior option. Here are a few specific advantages Roth IRAs have over their traditional counterparts.
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1. Roth IRAs give you tax-free retirement income
Perhaps the greatest benefit of saving in a Roth IRA is the ability to take tax-free withdrawals in retirement. Countless seniors struggle to manage their finances once they move over to a fixed income, so knowing that your nest egg is yours free and clear of taxes can make for a much less stressful existence when you're older.
2. Roth IRAs don't impose required minimum distributions
Once you reach age 70-1/2, you're forced to start withdrawing funds from your traditional IRA on a yearly basis. These withdrawals are known as required minimum distributions, or RMDs, and they're problematic for a number of reasons. First, you're required to pay taxes on RMDs, which can constitute a huge burden for many seniors. Secondly, that extra income might push you over the earnings threshold at which Social Security benefits become taxable, thereby subjecting you to an even greater tax bill. Finally, if you're hoping to leave money behind to your heirs, RMDs can easily thwart your plans.
The beauty of Roth IRAs is that they don't impose RMDs. Once you fund an account, the money you put in can sit and grow indefinitely. And if you want to pass on a portion of your nest egg to your beneficiaries, or even your entire nest egg for that matter, you're free to do so as you see fit.
3. Roth IRAs offer more flexibility
Let's be clear: Withdrawing funds from a retirement account prematurely is rarely a good idea, since the purpose of that money is to fund your golden years. That said, sometimes in life, we run into scenarios where we need cash and don't have an easy or cost-effective way to get it. Enter the Roth.
Whereas traditional IRAs penalize you for withdrawing funds prior to age 59-1/2 (unless you happen to qualify for an exception), once you fund a Roth IRA, your principal contributions are yours to remove at any time, and for any reason. This means that if your roof caves in and you need $15,000 for a new one, you can tap your Roth IRA rather than be forced into credit card debt. Again, the downside of going this route is that you won't have that $15,000 available when you're older -- but the option to withdraw it exists nonetheless.
Of course, not everyone agrees that Roth IRAs trump traditional IRAs on a whole. In fact, my colleague Dan Caplinger makes a pretty compelling case for choosing a traditional IRA instead of a Roth. But here's what you need to keep in mind about his arguments: While it's true that traditional IRAs give you an immediate tax break for contributing, you still get a tax break when you fund a Roth account. It just comes at a different time -- in retirement.
Furthermore, while you can't contribute directly to a Roth IRA if your earnings exceed a certain threshold, you still have the option to fund a Roth indirectly. All you need to do is convert some existing savings to a Roth, and pay taxes on the sum you move over at present.
Finally, while there's a good chance your tax bracket will indeed be lower in retirement than it is today, we also have no idea what tax brackets will look like down the line. For all we know, some future president will overhaul the tax system again, at which point you could get stuck paying a higher rate on your retirement savings. The benefit of saving in a Roth is that you're eliminating that risk by paying your taxes up front and getting them over with.
While saving for retirement in any account is better than not saving at all, if you really want to make the most of your nest egg, consider housing it in a Roth IRA. Though you'll miss out on some tax savings at present, you'll be thankful for it later on.
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