When it comes to saving for retirement, you have choices. You could contribute money to a traditional IRA or 401(k) for the tax break on the funds you put in. Or, you could save for retirement in a Roth IRA or 401(k).
Roth retirement plans have their benefits. Withdrawals from these accounts are tax-free, and they don't impose required minimum distributions.
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But there's a lot of confusion and misinformation about Roth accounts. Here are three myths you shouldn't believe.
1. Roth accounts make sense for everyone
You may have heard that every retiree can benefit from having a Roth account. But in reality, they don't automatically make sense for all savers.
If you expect to be in a lower tax bracket during retirement than during your working years, then a Roth account may not pay. If that's the case, you'd be funding your Roth account at a higher tax rate and withdrawing at a lower one, thereby capturing less savings and potentially costing yourself money.
2. You can tap your Roth account without a penalty at any time
One nice thing about Roth accounts is that if an emergency strikes or your financial situation changes, you can take a withdrawal without incurring a penalty, even if you're not yet 59 and 1/2. The logic on the IRS's part is that since you paid taxes on the money you put in, you won't be penalized for taking it out early.
But the way this rule works is that you can tap your principal Roth contributions early without a penalty -- not your gains. So if you put $50,000 of your own money into a Roth IRA that grew to $70,000, you can tap your $50,000 in principal contributions penalty-free. But if you touch the $20,000 in gains, you risk being penalized.
3. It's best to have all of your retirement savings in a Roth
Some people will say that it's best to have all of your retirement savings in a Roth account so you don't have to worry about taxes or being forced to take distributions. But there can be benefits to having taxable savings in retirement.
First, if you're charity minded and donate money out of your savings, you won't get a tax break unless those funds are coming out of a taxable account. Also, the IRS could introduce different tax credits in the future where eligibility hinges on having a taxable income. If you have all of your savings in a Roth account, you could miss out on money from the IRS.
It's important to know the ins and outs of Roth retirement plans if you're thinking of saving in one. It's also essential to recognize that Roth accounts aren't necessarily optimal for everyone, and that even if you open one, you may want to keep a portion of your money in a traditional IRA or 401(k) as well.
