Why Aren’t Roth IRAs for Everyone?

Some of the features of the Roth IRA make it look like a traditional IRA on steroids. There are no required minimum distributions and you have the ability to take withdrawals before you retire and you can even contribute to your Roth IRA after age 70 ½. However, it’s not for everyone.

A major factor in deciding whether or not to have a Roth IRA or a traditional IRA is your income. If you earn too much, you can’t contribute to a Roth. However, if you are in the early stages of your career and aren’t earning much, you may want to open a Roth now. That way, when you stop working and your income level drops, the Roth will be a great retirement income source because contributions are taxed but withdrawals are not.

Investopedia’s recent article, “When Not to Open a Roth IRA, ” explains that both types offer distinct tax advantages for those saving money for retirement. However, they work somewhat differently.

With a traditional IRA, you invest pre-tax dollars and pay income taxes, when you withdraw the money in retirement. You pay tax on both the original investments and what they earned. However, a Roth is the opposite: you invest money that’s already been taxed at the ordinary rate and withdraw it and its earnings tax-free at a later date.

In deciding one over the other, the key question is whether your income tax rate will be higher or lower when you start withdrawing funds. The other difference between the accounts is that RMDs are mandated by traditional IRAs. These are cash withdrawals from the account (on which you pay taxes) that must begin the year following the year in which its owner turns 70½. Roths have no RMDs.

For younger workers who have yet to realize their earning potential, Roth accounts have a definite edge. This is because when you first enter the workforce, it’s quite possible that your effective tax rate will be in the low single digits. Your salary will probably go up over the years. That means you’ll have greater income, and quite possibly be in a higher tax bracket in retirement. There is, therefore, an incentive to front-load your tax burden.

However, the opposite might be true, if you’re in your peak earning years. If you’re in one of the higher tax brackets now, it may have nowhere to go but down in retirement. If that’s the case, you’re probably better off postponing the taxes, by contributing to a traditional retirement account.

For the most affluent investors, the decision may be a moot point, because of IRS income restrictions for Roth accounts.

One thing is sure: there is no one-size-fits-all retirement account. You’ll have to look at your short- and long-term plan for investing and saving before deciding. The most important thing to remember: start saving early, and be consistent about saving, even if you can only put aside a small amount every year.

Reference: Investopedia (October 5, 2018) “When Not to Open a Roth IRA”