It's important to build up savings for retirement so you don't wind up overly reliant on Social Security once your career comes to an end. And in that regard, you have choices.
If your employer offers a 401(k) plan, you can consider contributing to it, especially if there's a match involved. But if you don't have access to a 401(k), or one with a match, then you may be better off saving in an IRA instead. IRAs commonly offer far more investment choices than 401(k)s, which could lead to not only stronger returns, but also, fewer fees.
But if you're going to save in an IRA for retirement, it definitely pays to consider putting your money into the Roth version. Fidelity reports that 64% of all IRA contributions during the fourth quarter of 2023 went into a Roth account. And here are a few reasons you should consider a Roth IRA as well.
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1. Tax-free gains
With a traditional IRA, you're not being taxed on investment gains year after year in your account. But if your savings gain a lot of value, you'll pay for it eventually when you take withdrawals. With a Roth IRA, your gains are yours to enjoy tax-free.
So let's say you contribute $300 a month to a Roth IRA over a 40-year period, during which time your portfolio generates an average yearly 8% return. That 8% is a bit below the stock market's average.
In that case, you'll end up with a balance of about $932,600 -- and at a cost of only $144,000. So all told, that's about a $788,600 gain. But that gains is yours to enjoy in full without the IRS coming after it.
2. Tax-free withdrawals
Many people find retirement stressful from a financial standpoint. That's because you've shifted from getting most of your money from a paycheck you earn to living off of savings and Social Security.
The nice thing about Roth IRAs is that you don't pay taxes on your withdrawals. So that's one less expense to worry about as a retiree.
Also, you should know that Social Security benefits can be subject to taxes based on your overall income picture. But since Roth IRA withdrawals aren't counted in the formula used to determine whether Social Security is taxed, by virtue of having one of these accounts, you might get more out of your Social Security benefits.
3. No required minimum distributions
Required minimum distributions, or RMDs, are designed to get you to spend down your tax-advantaged savings in your lifetime rather than pass on that money to your heirs. You'll be subject to RMDs with a traditional IRA -- but not a Roth. So if you want to leave money behind for future generations, that option should be on the table.
Even if you don't have heirs you're concerned about, you might simply want the option to leave your savings invested as long as possible. With a Roth IRA, you'll only have to take withdrawals when you deem it necessary. You won't have to remove a chunk of your savings every year because the IRS is threatening you with a penalty.
It's easy to see why saving in a Roth IRA is appealing to so many workers today. So if you've been sticking to a traditional IRA, you may want to consider a Roth IRA going forward. And if your income is too high to fund a Roth IRA directly, know that it is possible to contribute to a traditional IRA and convert it to a Roth after the fact.
