Choosing a Traditional or Roth IRA

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It can be difficult to choose between a traditional IRA and a Roth IRA. You may be wondering which type of IRA that you should open. There are advantages and disadvantages to both types of IRAs. Learn the basics of both a traditional and Roth IRA—and which is right for you.

Advantages and Disadvantages of a Traditional IRA

A traditional IRA can be a good option if you are looking to lower your taxable income. The contributions are tax-free, but you will pay taxes on your withdrawals. The major disadvantage is that you will pay taxes on more money since your money will grow once you invest it. However, you may be paying at a lower tax rate since you will likely be earning less once you are retired. 

Advantages and Disadvantages of a Roth IRA

A Roth IRA allows you to contribute money, but you are taxed on it. However, you will not be taxed on the withdrawals. This option does not lower your taxable income, but it does allow you to pay taxes on a lower amount of money since you are paying on your contributions instead of your withdrawals. This is a good option if you want to lower the amount that you pay in taxes once you retire. 

Keep in mind that there are salary caps on those who can open a Roth IRA. This limit was less than $122,000 in 2019. 

Choosing the Best IRA for You

You should consider not just your income as it relates to the income cap, but also when you would like to be taxes on your contributions—either when you make a contribution or when you make a withdrawal.

You should talk to your accountant or financial adviser to make sure that this choice really is the right one for you. If you feel you need the tax deduction, consider looking for other deductions or other ways to lower your taxable income.

It is important to take a long-term view when you consider the best IRA to open. Bank IRAs offer security while investment firm IRAs offer the chance for more growth. Each individual situation is slightly different and if you are unsure, it definitely helps to talk to your financial adviser or accountant. 

Considerations When Rolling a 401(k) Into an IRA

If you are trying to roll your 401(k) into an IRA, you may choose to keep it in the same type of account. Some companies only offer traditional 401(k)s. If you were to switch it to a Roth IRA, you will need to pay the taxes on the entire amount you are rolling over immediately. If you have the cash on hand, it can save you a lot in taxes in the future, but if you don't it may be easier to just roll it into a traditional IRA. When you are rolling a 401(k) over, what you are rolling over does not count against your contribution limits.

Opening a New IRA

When you open your IRA, you should choose an investing firm over a bank. The investing firm will allow you to invest in mutual funds or stocks. These options offer more potential growth for your investment, then you would get if you opened the IRA with CDs. When you are in your twenties, you have time to ride out the market, and you should invest more aggressively. However, your investments should grow more conservative over time.

Article Sources

  1. Fidelity. "IRA Rules." Accessed March 26, 2020.