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 cherished asset. So maybe you should consider retirement savings vehicles, one of which is the IRA. Depending on your income, you may have a choice 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 more confident you will be in choosing one.
First of all, the IRA shares some similarities. You can finance any of the many types of investments – stocks, bonds, mutual funds and so on. And 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 the Roth IRA is reduced. In 2021, you can invest 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 register 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 are usually tax deductible (subject to income limitation), and any earnings growth is deferred by tax, and taxes are owed when you withdraw money. With a Roth IRA, your contributions can never be tax deductible – instead, you contribute in dollars after tax. Any earnings growth is tax-free when withdrawn, provided you have your account for at least five years and do not withdraw money until you reach at least 59.5.
So which IRA should you 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. Given that you are in the early stages of your career, you may now be in a lower tax group than you will be during retirement, which will facilitate the tax deduction of traditional IRA contributions. So it may make sense now to contribute to the Roth IRA and withdraw non-taxable withdrawals when you retire.
Also, the Roth IRA offers more flexibility. With a traditional IRA, you could face a penalty for early withdrawal, in addition to taxes, if you withdraw money before you leave 59.5 years. But with Roth, you won’t be penalized for withdrawing the money you brought in (not for your earnings), and you’ve already paid the tax, so you could use the money for any purpose, such as a home payment. Nonetheless, you may still want to be careful about using an IRA for spending purposes before you retire, because IRAs are designed to provide retirement income.
If your income level allows you to choose a Roth or traditional IRA, you may need to consult with your tax advisor for assistance in choosing. But in any case, try to make the most of your IRA contributions 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 the use of local financial advisor Edward Jones.
Edward Jones, SIPC member