IRA options dependent on ‘how much time you have on your side’ before retirement: Expert

Silvur Founder and CEO Rhian Horgan joins Yahoo Finance Live to discuss tax season, the benefits of an IRA, and retirement planning options.

Video Transcript

DAVE BRIGGS: Americans have many choices when it comes to saving for retirement. One of those options is a Roth IRA. A Roth IRA is a type of retirement account you contribute to with after tax dollars. The main benefit of Roth IRAs-- your money and all earnings on that money can be withdrawn tax free, because what you contributed has already been taxed.

When you pull it out, you owe nothing. And this is different from a traditional IRA, where there, you contribute pre-tax income. So when you take money out, you have to pay taxes on that. So who is eligible to contribute to a Roth IRA?

If you are a single filer, you must have income under $153,000 for tax year 2023. And if you're married, file jointly, your combined income must be under $228,000 for tax year 2023. And if you choose this option, there are limits to how much you can contribute. You can contribute a minimum-- maximum, rather, of $6,500 if you're under age 50 for this year.

And if you're over the age of 50, you can contribute up to $7,500 for 2023. The big question, when can you pull your money out? Now, technically, you can pull the money out at any time, but there may be taxes as well as penalties. You can withdraw the money penalty and tax free after age 59 and 1/2 as long as your account has been open at least five years.

And you still have time to contribute to your Roth IRA for tax year '22 until tax day, April 18. You can contribute up to $6,000 if you're under 50 and up to $7,000 if you're over 50. For more on retirement savings, we turn to Rhian Horgan, Silver Founder and CEO in this week's Retirement Ready brought to you by Fidelity Investments. So who should be investing in a Roth IRA?

RHIAN HORGAN: Well, thanks, Dave. I think the easy one for the Roth IRA is someone who is young, and is lower income, and really has time on their sides, because the tax free compounding of returns can be great. There's a couple other folks, though, that are increasingly interested in Roth IRAs.

The first is individuals, actually, whose incomes are higher than the cap, but perhaps they're looking at Roth IRAs as a gifting strategy for kids or grandkids. So think about your child whose income might be lower than the cap or even a grandchild who maybe has their first or second job so is earning money, but you can actually gift them money into a Roth. And so they get the power of the compounding over their lifetime.

So that's one group. And the second group of people that we think about looking at IRAs today are actually folks that are close to retirement. And they're really thinking about doing what's called a Roth conversion or a backdoor Roth. So these are individuals that already have an IRA, but they are thinking about how they want to manage their withdrawals from their retirement accounts.

And one of the downsides of a traditional IRA, Dave, is that you have what are called required minimum distributions where you have to take money out of your account starting at the age of 73 in retirement. Roths are not subject to this rule. And so for many individuals who've seen their IRAs grow over time, they really like the idea of not being forced to withdraw and are considering conversions into Roth IRAs.

RACHELLE AKUFFO: So the people who are deciding between the traditional IRA and the Roth IRA, how do they determine what's the best fit for them?

RHIAN HORGAN: It's really, I think, two things you think about. The first is how much time do you have on your side? I think Dave mentioned early on that you need to have your money in a Roth, particularly during a conversion, for five years before you can take money out. But the second thing is really thinking about what your plans are longer term.

And if you can pay the taxes now and let that capital compound over time, that ability to take capital out later on in life tax free is really advantageous for many folks. I think one of the opportunities with Roths, which is really interesting today, is actually looking at the Roth 401(k). Many folks actually don't realize with their 401(k) that there's a Roth option.

And when you think about the cap on a 401(k), the cap on a 401(k), whether it's traditional or a Roth, is actually much higher than the caps you were just talking about. So the cap for a Roth 401(k) is over $20,000-- it's $20,500. And you can actually get employees-- or employers can actually match that.

So the Roth 401(k), I think, is this really, really valuable savings tool that many savers are not very familiar with. And it's a great way to increase that contribution higher than what a traditional Roth allows for.

DAVE BRIGGS: Potential downsides here?

RHIAN HORGAN: So potential downsides-- the first is if you're paying taxes today rather than putting it away tax free and your tax rates actually go down over time, you would have been better off actually being in a traditional 401(k). So, like, a Roth conversion, for example, can often make sense when you think that your tax rates are going to be higher in the future. But if tax rates go down, you would have been better off not doing that conversion.

Second thing, for folks that are thinking about conversions, you do need to live for five years after you do the conversion for the conversion to be effective. For folks who are thinking about Roth conversions later on in life, that's, obviously, something they need to really consider a little bit more.

RACHELLE AKUFFO: So for people who are trying to strategize, say you have a traditional 401(k) and you're like, should I max that one out and then put the additional into a Roth IRA? What are the best strategies to use when you're trying to figure out exactly which of the retirement accounts will really maximize.

RHIAN HORGAN: So, Rachelle, I think let's maybe take this starting from, like, from a younger person's perspective. One of the things to really think about that Dave mentioned early on is that there are income caps on contributing to Roth accounts, whether it's a Roth IRA or a Roth 401(k). So what that means is that if you're an individual who thinks that your salary and your earnings are going to go up over time, you really want to actually max out that Roth as early as possible in your earnings career, because there may come a point in time where you're actually not eligible to contribute any more. So I would always think about contributing to the Roth first. And then any excess, I would put in a traditional 401(k) or traditional IRA.

DAVE BRIGGS: All right, great information, very comprehensive. Rhian Horgan, great to see you. Thanks so much. Enjoy the weekend.