Retirement: Roth vs. Traditional IRA

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Today I want to discuss IRAs. If you have not heard of them, they are an awesome retirement option for Millennials to utilize.

An IRA is an individual retirement account. Individually, you can put $5,500 per year into a Roth or Traditional IRA. With a Roth IRA, you contribute money after you’ve paid taxes on it and then your money grows tax-free. That’s actually a really awesome deal and usually the best investment option for Millennials. In a Traditional IRA, you put money in before you pay taxes on it. In addition, you can usually deduct this contribution from your taxes if you don’t already have a retirement plan at work or if you make less than $71,000 a year.

If you make under $133,000 (for 2017), you should invest in a Roth IRA. If you make over $133,000 (as an individual or head of household), you can invest in a Traditional IRA and then later convert it to a Roth IRA, to take advantage of the tax-free growth. It’s usually pretty simple and easy to do a conversion.

If married filing jointly, you can contribute to an Roth IRA if you make less than $196,000.

Highlights of IRAs:

  • You can open up an Roth and/or a Traditional IRA in addition to any retirement option you have/participate in at work.

  • Both Roth and Traditional IRAs have annual (combined) contribution limits of $5,500 (or $6,500 if you are over the age of 50).

  • Roth IRAs allow you to contribute funds at any point in your life.

  • Traditional IRAs only allow contributions until the age of 70.5. At this age, you are required to start taking withdrawals (Note: this is for the Traditional IRA only. There is no such requirement for Roth).

  • You can contribute to an IRA up until April 15th (tax day) of the following year for the prior years contribution. For example, you can contribute for the year 2017 up until April 15, 2018.

  • You can easily rollover an old 401k into a IRA, usually into a traditional IRA (but then you can convert these funds into a Roth IRA and it then grows tax-free).

  • You have to be at least 59.5 before you can begin to make withdrawals from an IRA. Otherwise, there is a 10% federal tax penalty.

  • Roth IRA only has a 10% federal penalty tax on early withdrawals of earnings, but not contributions.

  • Traditional IRA has a 10% federal penalty tax on both contributions and earnings.

  • The exception to the early withdrawal penalty – first time home-buyers can withdraw up to $10,000 from their Roth IRA to use towards the purchase of their first home.

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It is important to remember IRAs are retirement vehicles that hold investments so you have to pick and build your portfolio (what goes inside it) – often this includes mutual funds, index funds, ETFs, and/or bonds. You can open an IRA broker account online. Examples of providers are Vangard, Betterment, TD Ameritrade, Scottrade, TIAA, Fidelity, Charles Schwab, E-Trade, Merrill Edge, Options House, Trade King, Wealthfront and more. Overwhelming much? Yup, there are a lot of options available.

I highly recommend Betterment, especially if you are new investor and/or want hands-free investing, but TD AmeritradeVangard and Fidelity are also great options if you are looking to DIY your portfolio. Go here if your would like to compare and contrast the different brokerage options.

 

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In general, you want to look for a broker that:

  • Has low or no account fees.

  • Has a wide selection of no-transaction-fee mutual funds and commission-free exchange-traded funds (ETFs).

  • Provides solid, exceptional customer service support and investor education resources (you need this especially if you’re a beginner).

  • Has low fund minimums. Some online brokers have a $0 initial deposit minimum, but the mutual funds require a minimum investment of $1,000 or more (sometimes the minimum is $10k). Until you build up to that amount, your money will just sit in a cash account, not making any earnings/returns. So, look for a broker that will allow you to start investing immediately with the money you have.

Overall, the clear winner is the Roth IRA (but all IRAs are great in general)! You can withdraw any contributions at any time, but it’s best to leave your money in so it can grow! You can actually leave the money your Roth forever and then bequeath it to someone when you die (i.e. spouse, children, grandchildren, etc.). This actually makes them a really great wealth transfer vehicles. Any beneficiaries of a Roth IRA do not owe income tax on withdrawals and can extend their distributions over a longer period of time.

Ready to open up an IRA now? Great!!

For more information on IRAs, visit the IRS page on them.

Special Offer: Sign Up with Betterment and get up to 6 months free using this link!


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