Do you know which individual retirement account (IRA) is right for you?
While a traditional and Roth IRA both share similarities such as maximum contribution limits and tax-free growth on your earnings, knowing the differences between them will make choosing the best one much easier.
Every teacher needs to plan for their retirement at every career stage. Besides your pension and 403(b)/457(b) savings accounts, contributing to an IRA, which is not tied to your employer, is a smart financial move in the wake of pension reform.
To learn exactly how IRAs work, check out this article we wrote comparing IRAs to 403(b) and 457(b) accounts.
Today we’re going to cover exactly what you need to know to determine your ideal IRA.
How Much Do You Earn?
We know teachers don’t make nearly what they should, but there are certain income restrictions that come standard when you go with a Roth IRA.
For example, if you and your spouse file your taxes jointly and earn over $194,000 combined, you cannot contribute to a Roth IRA so you’d need to choose a traditional one by default.
How Will Your Taxes Change In Retirement?
The major difference between a traditional and Roth is the way the taxes shake out.
When you invest in a traditional IRA, you’re allowed to deduct this money from your income taxes (depending on certain IRS rules), making your contributions potentially tax-free. During retirement, you’ll withdraw from your account and then have to pay income tax on your money.
Roth IRAs differ in that your contributions are considered post-tax, meaning they’re taxed on the front end. You won’t have to pay taxes on your withdrawals during retirement as you’ve already pre-paid the IRS in a sense.
Most retirees drop down to a lower tax bracket. This makes traditional IRAs the better option because your contributions will be tax-free and your withdrawals in retirement will be taxed at a lower rate. You’ll pay less in taxes overall.
However, if you’re anticipating staying in the same tax bracket, you may as well get your taxes out of the way with a Roth.
Further, if you’re already in a low tax bracket (hello, new teachers!), it may be a better idea to open a Roth because your contributions will be taxed at a lower rate now and you’ll enjoy tax-free withdrawals even if you’re in a higher tax bracket later (after you’ve earned some real money).
Are Your Investments Tax-Diversified Enough?
If you’re already contributing to a tax-deferred savings plan like a 403(b) account, you may want to open a Roth IRA so that you’ll have another form of income during retirement—and a tax-free stream of revenue at that.
When Do You Want to Stop Contributing?
Choose a traditional IRA and you won’t be able to contribute any more money when you reach the 70 ½-years old mark. On top of that, you have to start taking required minimum distributions (RMD), or withdrawals from your account, at this time.
On the other hand, you can make contributions to your Roth IRA and watch your investments grow well into retirement. This is an attractive offer for portfolios that do especially well. Plus, you’re never forced to take any RMDs so you can enjoy uninterrupted growth forever and pass on the account for another generation.
Neither traditional nor Roth IRAs are “better”; they each have their own distinctive ups and downs that depend entirely on your perspective.
After answering these questions, you should have a better sense of how these two options will work with your current and future taxes to guarantee more money in your pocket and less in Uncle Sam’s.