Under what circumstances should I invest in a Roth IRA?

Question

what are the pros & cons of the Roth IRA?

Answer 1

Ahhh, the million dollar question for Roth accounts...

And the answer is - it depends (sorry). Unfortunately, you need a crystal ball for this one. Your decision will likely come down to what you believe the future holds. You need to consider several factors, but you basically have two courses of action to take.

1) Take the sure thing - Invest in a Roth IRA, paying tax upon the contributions at your current income tax bracket, enjoy tax-free compounding of interest, and tax-free withdrawals of contributions and earnings through a qualified distribution (usually at retirement). Be careful, though...even if you are 90 years-old, your money must be in the Roth account for at least 5-years before qualifying for a tax- and penalty-free withdrawal. There are other benefits to having a Roth account versus a traditional IRA, such as the ability to get to your money without penalty for qualified reasons, such as needing to get to the money in order to purchase your first home. Contributions to Roth IRA's are subject to certain AGI limitations, so check with the IRS or a competent accountant first.

2) Let it Ride - Invest in a traditional IRA and enjoy a tax deduction today and tax-free compounding of interest until you are able to take a qualified distribution (usually at retirement) at which time you will pay taxes on the principal and earnings at your future income tax rate.

So, look into your crystal ball...

Do you believe that you will be in a higher tax bracket at retirement age than you are right now? If so, the Roth IRA option may be the right choice for you as you will likely pay less in tax today than you would 35 years from now. Likewise, if you believe you will be in a lower tax bracket in retirement, it makes more sense to simply contribute to a traditional IRA, enjoy your tax deduction today, tax deferral on earnings over the years, and pay the piper upon retirement.

There are several wild cards to consider in this scenario, not the least of which is the possibility that tax brackets change. If you want my honest opinion, I think it is naive to assume that the historically low tax brackets we enjoy today will be around in 30 years. I am 31 years old and, without getting political, just look at the current landscape of our country and its budget deficits. The cost of wars, strains on social security from aging baby boomers, etc, leads me to believe that the government is mortgaging our nation's current problems and our generation will likely have to pay for it. And how will we pay for it? Higher taxes. All things being equal - if you have more than 15 years until retirement, I would opt for the Roth IRA.

Answer 2

The differences of the Roth IRA and the Traditional IRA are pretty simple.

In a Traditional IRA, you put your money in, invest, and when you take your money out, you are taxed.

In a Roth IRA, you are taxed on what you put in, invest, and take your money out- tax free.

Technically, if you are in the same tax bracket before and after the IRA and you would pick the same stocks in either IRA, the money you end up with would be the same amount.

Therefore, you either give the IRS a lot of money later (Traditional IRA), or a little money now (Roth IRA).

The catch is, usually (hopefully) you are in a higher tax bracket when you retire so you'll end up with more money if you put your money in a Roth IRA.

Either way, don't forget to try to max out your IRA every year and do not get your money too early or you'll pay a hetfy penalty.

Good Luck

Answer 3

Money you put into a Roth IRA is not tax deductible. A regular IRA or 401K, the money that goes in is Pre-Tax money. You pay tax on money you put in the Roth.

However, money you take out of a Roth is not taxable. Money you take out of an IRA or 401K is taxable. So the major difference is, do you want to pay tax on the money now or later?

Usually people have a lower tax bill later. That's why the traditional IRA is ... well ... traditional. However, the Roth fills a strategic niche for people who wish to invest a little money now and expect significant returns over time.

For traditional investors like myself, first I fill up the 401K. If I have money left over, next I fill up the Roth. The second advantage is that you can't put money in both a regular IRA and a 401K. But you can have a 401K and a Roth, and benefit from both.

Answer 4

You pay taxes before investing in a Roth, so you don't have to pay taxes on what you put in when you take it out. It may help depending on your situation when you retire.