If you’re in the early stages of your career, you probably don’t think much about retirement. Regardless, it’s never too early to start preparing for it, because time can be your most valuable asset. So maybe you should consider retirement savings vehicles, one of which is the IRA. Depending on your income, you could choose between a traditional IRA and a Roth IRA. What is better for you?
There is no one right answer for everyone. But the more you know about two IRAs, the safer you will be when choosing one.
First of all, IRAs share some similarities. You can finance any of them with many types of investments – stocks, bonds, mutual funds, etc. The contribution limit is the same — you can invest up to $ 6,000 a year. (Those over the age of 50 can invest an additional $ 1,000.) If you earn more than a certain amount, your ability to contribute to Roth IRAs is reduced. In 2021, you can enter a full $ 6,000 if your modified adjusted gross income (MAGI) is less than $ 125,000, and if you are single or $ 198,000 if you are married and claiming together. The amount you can contribute gradually decreases and is eventually limited to higher income levels.
But the two IRAs differ greatly in the way they are taxed. Traditional IRA contributions can usually be deducted from taxes (subject to income limits), and any earnings are deferred for taxes, and taxes fall due when you withdraw funds. With a Roth IRA, your contributions can never be tax deductible — instead, you contribute after the dollar. Earnings are tax-free when raised, provided you have an account for at least five years and do not take funds to withdraw until you are at least 59 years old.
So which IRA to choose? You will need to weigh the respective benefits of both types. But when you’re young, you may have particularly compelling reasons to choose the Roth IRA. Since you are in the early stages of your career, you may now be in a lower tax bracket than you will be at retirement, making the tax deduction of traditional IRA contributions less useful. So it might make sense to contribute to the Roth IRA now and take tax-free withdrawals when you retire.
Also, the Roth IRA offers more flexibility. With a traditional IRA, you could face the penalty of early withdrawal, in addition to taxes, if you withdraw money before you turn 59 years old. But with Roth, you won’t face a penalty for withdrawing money from your contribution (not your earnings), and you’ve already paid taxes, so you could use the money for any purpose, like paying an advance on the house. Nonetheless, you may still need to be careful when using your IRA for your spending needs before you retire, as IRAs are designed to provide retirement income.
If your income level allows you to choose a Roth or traditional IRA, you may want to consult with your tax advisor to help with the selection. But in any case, try to make the most of your contributions to the IRA each year. You could spend two or three decades in retirement – and your IRA can be a valuable resource to help you enjoy those years.
This article was written by Edward Jones for use by your local financial advisor Edward Jones.
Edward Jones, SIPC member
