When it comes to building your retirement nest egg, you have choices. You could opt to save for your later years in a traditional IRA. Doing so gives you a tax break on your contributions on top of tax-deferred investment gains.
But a Roth IRA could end up being an even better retirement savings plan for you. With a Roth IRA, you won't get a tax break on your contributions, but your money will grow tax-free and the withdrawals you take as a retiree will be yours free and clear of taxes.
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Plus, Roth IRAs don't impose required minimum distributions (RMDs). So if you don't need to tap your savings every year, you won't have to.
Another nice thing about Roth IRAs is that these accounts give you more flexibility with your money than traditional IRAs. But taking advantage of that flexibility could leave you feeling sorry after the fact.
When there's too much temptation to tap your savings ahead of retirement
Because you don't get a tax break on the money you put into a Roth IRA, you're not penalized for tapping that account ahead of retirement age, provided you're touching the principal portion, not gains. This means that you can use a Roth IRA to fix up your kitchen or repair your car -- if you so choose.
That might seem like a convenient thing to do when you're facing a larger expense. But remember that the more money you take out of your Roth IRA ahead of retirement, the less you'll have available in retirement. And if you keep hitting up your savings while you're still working, you'll risk having a shortfall once retirement rolls around.
Remember, too, that when you withdraw from a Roth IRA ahead of retirement, the money you pull out stops growing because it's no longer invested. So you lose out on not just the sum you remove, but potential gains. That sort of hit could be huge.
Is a Roth IRA right for you?
There are plenty of benefits to saving for retirement in a Roth IRA. But if you don't trust yourself not to tap that account ahead of time, you may want to stick to a traditional IRA, instead. The idea of facing a 10% penalty on early withdrawals may be enough to sway you to leave your money alone.
Plus, for some people, a traditional IRA can make more sense financially. If you expect to be in a lower tax bracket in retirement than you are as a full-time worker, a traditional IRA may be a better choice. That way, you'll be getting a tax break when your IRS burden is highest.
Another major perk of having a Roth IRA is avoiding RMDs. But if you expect to tap your savings regularly once you enter retirement, RMDs may not matter to you -- you might be taking that money out of your account whether you have to or not.
Before you rush to open a Roth IRA, think about whether it's the best choice for you. And if you do decide to go with a Roth IRA, remind yourself what that money is there for -- and pledge not to take withdrawals until your career actually comes to a close.
