CTYP member David Cikatz shares his expertise in financial advice for young professionals.
If you’re in the early stages of your career, you’re probably not thinking much about retirement. Nonetheless, it’s never too soon to start preparing for it, as time may be your most valuable asset. So, you may want to consider retirement savings vehicles, one of which is an IRA. Depending on your income, you might have the choice between a traditional IRA and a Roth IRA. Which is better for you?
There’s no one correct answer for everyone. But the more you know about the two IRAs, the more confident you’ll be when choosing one.
First of all, the IRAs share some similarities. You can fund either one with many types of investments – stocks, bonds, mutual funds, and so on. And the contribution limit is also the same – you can put in up to $6,000 a year. (Those older than 50 can put in an additional $1,000). If you earn over a certain amount, though, your ability to contribute to a Roth IRA is reduced.
But the two IRAs differ greatly in how they are taxed. Traditional IRA contributions are typically tax-deductible (subject to income limitations), and any earnings growth is tax-deferred, with taxes due when you take withdrawals. With a Roth IRA, though, your contributions are never tax-deductible – instead, you contribute after-tax dollars. Any earnings growth is tax-free when withdrawn, provided you’ve had your account at least five years and you don’t take withdrawals until you’re at least 59.5 years old.
So, which IRA should you choose? You’ll have to weigh the respective benefits of both types. But when you’re young, you may have particularly compelling reasons to choose a Roth IRA. Given that you’re at an early point in your career, you may be in a lower tax bracket now than you will be during retirement, making the tax-deduction of traditional IRA contributions less beneficial. So, it may make sense to contribute to a Roth IRA now and take tax-free withdrawals when you’re retired.
Also, a Roth IRA offers more flexibility. With a traditional IRA, you could face an early withdrawal penalty, in addition to taxes, if you take money out before you’re 59 and a half. But with a Roth, you’ll face no penalty on withdrawals from the money you contributed (not your earnings), and you’ve already paid the taxes, so you could use the money for any purpose, such as making a down payment on a home. Nonetheless, you may still want to be cautious about tapping into your IRA for your spending needs before you retire, since IRAs are designed to provide retirement income.
If your income level permits you to select a Roth or traditional IRA, you may want to consult with your tax advisor for help in making your choice. But in any case, try to max out on your IRA contributions each year. You could spend two or three decades in retirement – and your Roth IRA can be a valuable resource to help you enjoy those years, tax-free!
This article was written by David Cikatz, an Edward Jones Financial Advisor.
Contact him at David.Cikatz@edwardjones.com for specific questions.
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