It's hard to find a retirement account that gives you more control over your funds than an IRA. You can invest your money however you'd like and change your asset allocation as often as you want -- something most 401(k) savers can only dream of.
You can also decide how you'd like the government to tax your savings, but that raises an important question: Is a traditional or a Roth IRA better for you? Here's what you need to know to decide.
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Traditional IRAs
Traditional IRAs are tax-deferred accounts, which means they give you a tax break when you make your contributions. If you put $5,000 in a traditional IRA right now, you'd reduce your 2023 taxable income by the same amount. But since you're getting your tax break up front, the government will expect a share of your contributions and your earnings when you withdraw money later on in retirement.
These accounts can be a good fit for those who believe they're in a higher tax bracket now than they'll be in once they retire. By delaying taxes until their income is lower, they could lose a smaller percentage of their savings to the government compared to paying taxes up front.
But you can only put off taking your withdrawals for so long. Traditional IRAs have required minimum distributions (RMDs) that begin the year you turn 73. These are mandatory annual withdrawals you must take from your IRA in order to give the government its cut of your savings. Failing to take RMDs isn't really an option because you'll pay a 25% penalty on the amount you should have withdrawn.
If you decide a traditional IRA is right for you, you can put up to $6,500 here in 2023. Adults 50 and older may make an additional $1,000 catch-up contribution if they choose.
Roth IRAs
Roth IRAs are popular because they offer tax-free withdrawals of your retirement savings. You can take out your contributions at any age, but you must wait until you're at least 59 1/2 and have had your Roth IRA for at least five years before you can withdraw any earnings tax-free.
The government is willing to ignore these withdrawals when calculating your taxable income for the year because you pay taxes on your contributions in the year you make them. For this reason, they're most popular among those who expect their tax bracket to rise or stay the same once they retire.
Since you don't owe taxes on your withdrawals, you also don't have to take RMDs from Roth accounts. This makes them a great place to store savings you'd like to pass onto your heirs, assuming you can put money in one of these accounts in the first place.
Roth IRAs also have income limits that determine how much you can set aside in one of these accounts based on your annual income. Most people can contribute up to $6,500 in 2023 or $7,500 if they're 50 or older. But higher earners aren't allowed to contribute as much, and some may not be able to put any money directly into a Roth IRA.
In this case, the decision about whether to use a traditional or Roth IRA is pretty easy. If you can only put money in a traditional IRA, that's where your savings should go. But if you really want Roth savings, you could make a backdoor Roth IRA. This is where you make a traditional IRA contribution and then do a Roth IRA conversion. It's a few more hoops to jump through, but it'll help you accomplish the same goal.
Which appeals more to you?
Hopefully, this information has helped you figure out whether a traditional or a Roth IRA is a better fit for you in 2023. Keep in mind that the right account for you could change over the years. A Roth IRA could be a good fit for you right now, but you may prefer a traditional IRA in the future.
It's also possible to use both types of IRAs if you want, but you should favor whichever one you believe offers you the greatest tax advantages. And you need to stay mindful of the annual contribution limits.
The limits described apply to all your 2023 IRA contributions, not to each account individually. Be sure that you don't set aside more than $6,500 (or $7,500 if 50-plus) in total this year. If you want to save more, consider pairing your IRA with another retirement account.
