If you’re saving for retirement, you have a few options. First and foremost, if you have a company match where your employer matches your contributions to your 401(k) plan, you should invest enough in that account to earn the full match. There’s almost never a reason to pass up this free money.
Once you’ve done that though, or if your company doesn’t have a 401(k) match, putting money into an IRA can be a good option. You can open an IRA at any brokerage firm and gain access to more investment choices than a typical 401(k) offers while still scoring retirement tax breaks.
There are actually different kinds of IRAs you can choose from, but one is far more popular than others. Find out why and how to tell if it may be right for you.
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Most IRA contributions go into this kind of account
According to Fidelity, the vast majority of IRA contributions end up going to a Roth IRA, rather than a traditional one. In fact, 61.2% of all IRA contributions that are made go into a Roth IRA.
A Roth IRA is a tax-advantaged account you can invest in for retirement. But unlike your 401(k), you don’t take a deduction for the amount you contribute in the year you invest. Instead, you contribute post-tax dollars. When you get to retirement, though, you can withdraw money without paying any taxes on it. There are also Roth 401(K) accounts available, although not all employers offer them.
A Roth IRA is an alternative to a traditional IRA. A traditional IRA is more like your standard traditional 401(k) account. You get to take a tax deduction for the amount you contribute to it in the year you invest. But when you get to your retirement, you are taxed on withdrawals.
The Fidelity data shows many more people are opting to defer their tax break, claiming it later as a senior rather than right now. But is that a good idea?
Is a Roth IRA the right choice for you?
There are a few key benefits of a Roth IRA compared to a traditional one, which may make a Roth the right choice for many people.
Take advantage of lower taxes now
First, if you expect you will be in a higher tax bracket in retirement than you’re in now, a Roth IRA makes the most sense. You’re better off claiming your tax savings later when you’d otherwise be taxed at a higher rate. You could find yourself with a higher tax rate in retirement compared to now if your income goes up over time, or if the government acts to raise tax rates in the future — which is a very real possibility since rates right now are pretty low by historical standards.
If you’re already contributing to a traditional 401(k), a Roth IRA gives you more diversification in your retirement savings. Your 401(k) comes with the tax break now rather than later, so by opting for a Roth IRA, you have accounts providing tax savings at different times. This allows you to hedge your bets since it can be really hard to know if your tax savings will be more now or in the future.
You aren’t required to take withdrawals from these accounts on any set time frame. By contrast, both traditional IRA and 401(k) accounts are subject to rules mandating required minimum distributions. Basically, you have to start taking money out of them based on an IRS table or you’ll be penalized. So if you don’t want the government making you withdraw from the account, a Roth makes more sense.
Avoid Social Security taxes
Investing in a Roth could also help you avoid taxes on Social Security. See, Social Security calculates “provisional” income by adding up half of your Social Security retirement benefits, some non-taxable income like MUNI bond interest, and all taxable income. Once single filers have $25,000 in provisional income or married joint filers have $32,000, you’ll have a federal tax bill to pay on benefits. But Roth distributions don’t count, so you can bring home more money without triggering a tax on benefits.
For all these reasons, it’s clear why Roth IRAs are so popular. When you’re investing for retirement, you should seriously consider putting your money into one once you’ve maxed out your 401(k) match.
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