Should You Choose a Roth IRA or Traditional IRA — or Both?

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If you’re considering ramping up your retirement contributions prior to tax time, as many Americans are, you may be wondering about the advantages of a Roth IRA over a traditional IRA. 

See: Traditional IRA vs. 401(k): Which Is Best?
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First, understand this: a Roth IRA will not reduce your taxable income right now. Unlike traditional IRAs, Roth IRAs are not tax-deferred, Fidelity Investments writes in its one-pager, “Traditional or Roth IRA, or both?” Contributions aren’t tax deductible, but you can withdraw the money tax-free in retirement as long as you meet eligibility requirements. On the other hand, you’ll pay taxes on your traditional IRA contributions when you withdraw the money. 

One reason to choose a Roth IRA over a traditional IRA is if you’d rather reap the tax savings later rather than now. However, if you’re looking to reduce your taxable income, a traditional IRA is the way to go. 

The Roth IRA has upper income limits, Fidelity reports, which means it may not be the best choice for everyone. But, you can convert a traditional IRA into a Roth IRA to give you added flexibility at any time, regardless of your income level. Fidelity Investments notes that more people have adopted this tactic in the past year, with a 27% increase in the number of Roth IRA conversions in the first quarter of 2020 versus 2019. 

Are You Retirement Ready?

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Have You Maxed Out Your IRA Contributions?

If you’ve maxed out your IRA contributions or have another retirement plan, such as a 401K or 403(b) through your workplace, that also permits tax-deductible contributions, you may have maxed out your deductions. These accounts, Fidelity reports, often have higher contribution limits, so it pays to max out these accounts first. 

If you’ve done that, and are looking to save even more for retirement, a Roth IRA may fit the bill as the tax deductions right now aren’t important to you. 

How Will You Spend the Money You Save With a Traditional IRA?

Tax-deductible contributions often sound appealing as they can put more money in your pocket for a vacation, home improvements, or other discretionary expenses. 

However, if your goal is to save for retirement, why not make the maximum contribution into a Roth IRA and enjoy the tax savings later, when you withdraw the money, Fidelity says. 

“How disciplined you are at saving can also play a role in which type of account may better help you prepare for retirement,” says Matthew Kenigsberg, vice president of investment and tax solutions at Fidelity in a Fidelity Viewpoints column about IRAs. “In a sense, switching from a traditional IRA to a Roth IRA forces you to save more for later by keeping less in your pocket now, assuming you keep making the same contribution.”

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Are You Retirement Ready?

Of course, if you have high-interest credit card debt, medical bills or a dwindling savings account, it makes sense to aim to increase your tax refund for financial savings and peace-of-mind.  

Roth IRAs for Estate Planning

Unlike a traditional IRA, which has required minimum distributions (RMDs), you don’t have to take money out of your Roth IRA if you don’t want to when you reach retirement. You can also distribute the money in a Roth IRA to your heirs, income tax-free, when you die. For this reason, Fidelity recommends Roth IRAs as one estate planning tool. 

Roth IRA or Traditional IRA?

For many people, diversifying retirement investments between both types of accounts, as well as ETFs and mutual funds, could be the best strategy. Fidelity advises choosing your IRA carefully, with an age-appropriate mix of investments. Younger investors, under the age of 40, can yield higher returns with investments that carry some risk, while older investors may want to be more conservative. 

If you’re just starting to save for retirement, a growth-oriented investment can help get you there in a reasonable time frame.

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