The decision of whether to open a Roth IRA or Traditional IRA is a very important one. In doing an investigation online, I came across the website at the link below that gives a good comparison on the features of both types of accounts.
But, in my mind, the decision can basically be narrowed down by answering two questions:
1) Do you meet the qualifications needed to open a Roth IRA?
In order to open a Roth IRA, you must have earned income of less than $95,000 (single) and $150,000 (married couples filing together).
2) When is it more beneficial for you to pay the taxes on the proceeds from your account?
In the case of a Roth IRA, you contribute after-tax income to your account. However, when you withdraw it at retirement, it is tax free! This is incredibly generous that the government gives us this tool to invest with.
In the case of a traditional IRA, you contribute pre-tax income to your account, and then pay taxes on the earnings when you withdraw the money (much like a 401k account).
So, if you are young like I am (24 years old) making a middle-class salary (under $95,000 limit), but you are investing money prudently and hoping that the miracle of Time Value of Money will cause your nest egg to grow, you will most likely be in a lower tax bracket now than you will be when you retire and withdraw the money (lower tax bracket = lower taxes). Therefore, it is more beneficial for me to use a Roth IRA and pay the taxes now vs. later.
General Rule of Thumb – from David Bach’s book, Fight For Your Money
- If you’re under 35 years of age, a Roth IRA is the way to go.
- If you’re 50 or over, a Traditional IRA is the way to go.
See! Not too difficult right? Let me know if you have any questions.
Keep on learning!
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