Wherever you get your financial education – whether it’s from friends, social media, a financial planner or an expert newsletter – you’ve likely heard of a Roth IRA. Roth accounts are used frequently and are often an important part of your retirement savings strategy.
So, should you have one? As always, when it comes to financial planning, it depends on your personal world. A Roth IRA can be an extremely valuable vehicle for retirement and tax strategies if used correctly. But contrary to what you may hear, it doesn’t make sense in every situation.
What Is A Roth IRA?
This is a type of tax-advantaged individual retirement account, where you contribute after-tax dollars toward your retirement.
What’s The Difference Between A Roth IRA And A Traditional IRA?
A Roth IRA is made with after-tax dollars. So, there are no tax benefits today. However, all earnings grow tax-free, and after age 59 1/2, all withdrawals are tax-free. A traditional IRA is made with pre-tax dollars and your earnings grow tax-deferred. So you save on taxes today. But those taxes are just deferred, and you pay taxes when you withdrawal your money.
Another significant difference is you don’t have to take required minimum distributions from a Roth IRA. This can be a huge benefit if you don’t need money from your IRA during retirement, and you want to allow it to continue growing tax-free.
When Does A Roth IRA Make Sense?
If you think you’ll be in a higher tax bracket when you retire, a Roth IRA is probably the best choice. Workers just starting out in their careers could benefit from a Roth contribution because their current tax rate may be at 12%. But when they retire they may have to pay taxes at the 32% rate. Another often overlooked strategy for contributing to a Roth IRA is when you have an unusually low-income year. If you lost your job and made significantly less money that year than normal, a Roth IRA could help ease the blow by providing tax benefits.
Another time when a Roth makes sense is if you don’t plan on needing retirement income during your golden years. Traditional IRAs and 401(k)s require you to take RMDs every year after age 72 (73 if the account owner reaches age 72 in 2023 or later). This not only counts as taxable income, but you no longer allow your money to grow tax-free. If you don’t need your income, Roth accounts allow it to grow untouched. This is also beneficial in estate planning if you plan to pass wealth to your children, Investopedia explains.
How Much Should I Contribute To A Traditional Or Roth IRA?
Both types of IRAs have 2024 contribution limits of $7,000 ($8,000 if you’re age 50 or older). But there are income requirements when you open a Roth IRA. Your eligibility and how much you can contribute is determined by your Modified Adjusted Gross Income. If you are a single or joint filer, your maximum contribution starts to reduce at $146,000 (single) and $230,000 (joint) for tax year 2024. Once your income reaches $161,000 (single) and $240,000 (joint) you no longer can contribute to a Roth IRA. Keep in mind you can contribute to both, as long as the combined doesn’t exceed the total contribution limits above.
What’s The Verdict?
Often times, the best strategy is a balanced one. There are benefits to having some of your retirement in Roth and the rest in traditional IRAs and 401(k)s. If you’re still unsure, it can be helpful to discuss your tax and retirement plans with an accountant or financial planner before making any big moves.
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