Roth IRA vs Traditional IRA

There are many ways to save for retirement, but Individual Retirement Accounts (IRAs) are the chosen vehicle for millions of Americans. In 2020, the estimated value of assets in IRAs was around 19 trillion U.S. dollars. And these assets aren’t only in the hands of older Americans. A recent survey found that more than 42 percent of millennials have retirement accounts. While that’s relatively high compared to other generations at this point in their lives, there’s always room to improve.

An IRA can not only help Americans at any stage of life start saving for their retirement, but also help them build their net worth, perhaps to the end of achieving an accredited investor status certificate.

But when it comes to IRAs, there is more than one option. In addition to SEP-IRAs, which are available to self-employed individuals, there are Traditional IRAs and Roth IRAs. And the difference between them has a critical impact on how the funds are taxed.

The Difference Between Roth IRAs and Traditional IRAs

Roth IRAs and Traditional IRAs are both built to incentivize people to save for retirement. They do this by providing certain tax advantages, but they do so in different ways. However, the mechanics are fairly similar: the account owner contributes a set amount of funds (up to a limit) into their account with a brokerage and then invests those funds so that they grow until the account owner is ready to retire.

When signing up for a retirement account, however, it’s important to know the differences between the two popular types of IRAs so you can select the investment vehicle right for you.

Taxation

With a Traditional IRA, you contribute pre-tax dollars and your money grows tax-deferred. When you reach 59 and a half, you can then make withdrawals from your account. Each withdrawal will be taxed at your regular income tax rate at the time of withdrawal. 

With a Roth IRA, you contribute after-tax dollars and your money grows tax-free. When you reach 59 and a half, you can also start to take withdrawals. However, your withdrawals will not be taxed as the funds you contributed were already taxed.

This is one of the most important differences between Roth IRAs and Traditional IRAs because it directly affects your income in retirement. With a Traditional IRA, your retirement paycheck will be subject to whatever income tax bracket you are in. If you suspect you may be in a higher tax bracket come retirement than you are now, a Roth IRA may be the better choice. If, however, you believe you’re in a higher tax bracket at the time you contribute to your account than when you retire, a Traditional IRA might be best. While it may be difficult to predict, you have the best idea of your current financial situation and what you hope it will be in the future.

Remember, that tax rates change, and tax rates at the time you retire may be higher than they are now. 

Contributions

It’s also important to note that Roth IRAs are only available to people below a certain threshold of income. For 2022, this threshold is:

• $129,000 to $144,000 - Single taxpayers and heads of household

• $204,000 to $214,000- Married, filing jointly

• $0 to $10,000 - Married, filing separately

For those who have an accredited investor certificate through means other than the income method, a Roth IRA may be feasible.

Saving and investing for retirement is critical, but there are many ways to do so. In addition to an IRA or Roth IRA, you may want to consider investing in other ways, such as private offerings. To learn more and stay up to date on various investment avenues, bookmark verify investor.