One question I often hear is “Should I use a ROTH or a Traditional IRA in savings? “  I consider these two individual retirement savings as paternal twins.  Each share something similar, like twins share a birthdate, both help you save for retirement.  But each is very different, paternal twins don’t look alike, and these IRAs have different features upon withdrawal.  We spoke about Traditional IRA in a previous video that can be found on this YouTube channel. This is ROTH IRA’s turn!

Roth IRAs are tax-favored financial vehicles that enable investors to save money for retirement. They differ from traditional IRAs in that taxpayers cannot deduct contributions made to a Roth. However, qualified Roth IRA distributions in retirement are free of federal income tax and aren’t included in a taxpayer’s gross income. That can be advantageous, especially if the account owner is in a higher tax bracket in retirement or taxes are higher in the future.

A Roth IRA is subject to the same contribution limits as a traditional IRA. The maximum combined annual contribution an individual can make to traditional and Roth IRAs is $6,000 in 2022, unchanged from 2021. Special “catch-up” contributions enable those nearing retirement (age 50 and older) to save at an accelerated rate by contributing $1,000 more than the regular annual limits.

Another way in which Roth IRAs can be advantageous is that investors don’t have to begin taking mandatory distributions due to age, as they do with traditional IRAs; however, beneficiaries of Roth IRAs must take mandatory distributions.

Withdrawals of your own contributions are tax-free and not subject to the 10% federal income tax penalty for early withdrawal. In order to make a qualified income tax-free distribution of earnings (in essence a qualified withdrawal), the account must meet the five-year holding requirement and the account owner must be either (a) age 59½ or older, (b) disabled, (c) deceased (and assets pass to beneficiaries) or (d) purchasing a first home ($10,000-lifetime limit). Otherwise, withdrawals of earnings are subject to ordinary income tax and the 10% federal income tax penalty. Certain additional exceptions apply, reach out to me for more details.

So why can a ROTH IRA be great for you?

  1.  Roth IRA distributions in retirement are free of federal income tax and aren’t included in a taxpayer’s gross income. 
  2.  With a ROTH IRA as part of your retirement portfolio, you don’t have to begin taking mandatory distributions due to age. (Keep in mind that beneficiary IRAs play by a different set of rules, reach out to me if you want to talk about that more.)
  3. Early withdrawal of funds can be made and are exempt from the 10% early withdrawal penalty when certain limits are met.

If you are young, and in a lower tax bracket I urge you to highly consider adding savings to a ROTH as part of your financial plan.  Keep in mind that your ability to save into a ROTH might be limited as you build your success, so starting sooner than later would be advantageous. 

As life moves forward and your income increases, you become a dual-income family, and kiddos come along, tax-deferred savings into a traditional IRA might be a better choice than a ROTH IRA. Your Financial Advisor can help you make the right decision.  Jump onto a Discovery Session if you’d like to talk about the power of ROTH savings and if it’s the right savings strategy for your situation.  Oh, and 401(k) ROTH, hubba-hubba – that is another video blog in the future.

Thank you for joining us for this episode of Widow & Wisdom (your wealth edition), where your mindset and money matter most. Be sure to like and share us with your friends and loved ones and follow us on Instagram for more practical money talks for families in transition.