When it comes to saving money for retirement, you have different options to look at. You could park your money in an employer-sponsored 401(k), or look at a traditional IRA.
Many financial experts, however, will tell you that if you're eligible for a Roth IRA, then it pays to make that your retirement savings plan of choice. And even if you earn too much to fund a Roth IRA directly, you can always contribute money to a traditional IRA and convert it to a Roth afterward.
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Now it's true that Roth IRAs have their share of benefits. But these plans aren't perfect, either.
First, let's get into the upside of saving for retirement in a Roth IRA. Here are three perks you might enjoy.
1. Withdrawals are tax-free
You may find that money is tighter in retirement than it is while you're working. One benefit of housing your retirement savings in a Roth IRA is getting access to tax-free withdrawals. And keeping the IRS away from your money is important at a time when you don't have a paycheck coming in from a job.
2. Withdrawals won't raise your risk of being taxed on Social Security benefits
If your non-Social Security income exceeds a certain threshold, you could end up liable for taxes on your benefits. And withdrawals from a traditional IRA or 401(k) will count for those purposes. Roth IRA withdrawals, however, will not.
You can take $2,000 out of your Roth IRA in a given year or $20,000, and it won't matter -- that income won't push you any closer to being taxed on Social Security. That might allow you to withdraw from your savings without having to worry about negative repercussions.
3. You won't have to take RMDs
RMDs, or required minimum distributions, force you to remove a portion of your retirement savings each year or otherwise face a penalty. Right now, Roth IRAs are the only tax-advantaged retirement plan to not impose RMDs. Come 2024, Roth 401(k)s won't impose them either.
But no matter what, not having to spend down your plan balance in your lifetime is huge. It means you can let your invested money continue enjoying tax-advantaged treatment, and it also means you can leave a large chunk of your savings to your heirs if you so choose.
The one Roth IRA drawback you need to know about
Clearly, there are plenty of good reasons to opt for a Roth IRA. But one downside to saving in a Roth IRA is that you're allowed to withdraw your principal contributions at any age without penalty. That might seem like a good thing, but it actually isn't.
With a traditional IRA or 401(k), you'll be penalized for taking a withdrawal prior to age 59 1/2 because you'll have already received a tax break on the money you contributed. With a Roth IRA, there's no up-front tax break on the money you put into your account. As such, the IRS doesn't care if you withdraw your funds early, provided you're only removing the principal portion of your account, and not the gains portion.
But because Roth IRAs offer that flexibility, you may be tempted to tap your savings every time a need for money arises. And that could leave you dangerously short on savings later in life.
So if you're going to save for retirement in a Roth IRA, pretend the option to take penalty-free withdrawals doesn't exist. And if you don't trust yourself to leave your savings alone, you may want to stick to a traditional retirement plan instead. You'll give up some of the perks above, but you might lower your risk of depleting your retirement savings before your career actually comes to an end.
