I’m not sure it is possible to make the current retirement savings options more confusing. Between the 401(k), 403(b), IRA, Roth IRA, Roth 401(k), and SEP IRA we have tons of options and little idea about the differences between each option. In general an IRA is an account you will set up for yourself, while a 401(k) or 403(b) are retirement accounts your employer sets up. A common question I hear is “Does it matter if I invest in a Roth or Traditional IRA?” It definitely does make a difference so let’s look at how each type of IRA works to help you make this decision.
ROTH IRA BASICS
I created a graphic to illustrate the basic facts of a Roth IRA
TRADITIONAL IRA BASICS
Here is a graphic to highlight the basics of a Traditional IRA
SHOULD I CHOOSE A ROTH OR TRADITIONAL IRA
First things first, saving for retirement is a good idea anyway you slice it. Don’t get caught up trying to make the perfect decision. Either option is a good option and ultimately you are taking a guess about the future.
Not everyone is eligible to contribute to a Roth IRA or a Traditional IRA. As you saw in the graphics if you make above a certain income you cannot contribute. To check your eligibility look at your tax return to calculate your modified adjusted gross income. Detailed view of Roth Limits. Detailed view of Traditional IRA limits.
Once you have determined your eligibility you want to think about your current income and your future income, at age 59.5. The general rule of thumb is if you think your earning more and paying higher taxes now (and you will pay lower taxes in the future) then you should choose a Traditional IRA. If you think you are paying lower taxes now (and will pay more in the future with a higher income) than choose a Roth IRA.
This article is a basic overview of the differences between Roth and Traditional IRAs. Please discuss your personal situation with your financial advisor or with the brokerage firm where you will open your account.
Know someone who is trying to decide between a Roth and Traditional IRA? Forward these graphics their way.