Roth IRA Explained

At one point or another you probably wondered whether you should contribute to a Roth IRA or a Traditional IRA. While I can’t tell you which one is best for you, I can tell you my own thought process and hope you can use it to decide which one is better for you.

For me, I had access to a 401(k) through my employer. A 401(k) is like a Traditional IRA, it’s a tax deferred retirement option, though I can get an employer match for my contributions. In 2008, I can contribute $15,500 towards the 401(k), far exceeding the $5,000 I can put in a Traditional IRA. Another consideration was that because I had access to a 401(k) and because my income was above the deductibility ceiling, I couldn’t deduct Traditional IRA contributions. Even if I could, I still would pick a Roth IRA because I would rather diversify my tax profile and put $15,500 (or less) tax-deferred in a 401(k) and then $5,000 tax-free in a Roth IRA.

The Roth IRA is best for when you think your current marginal tax rate will be lower than your retirement tax rate. That makes it idea for young professionals, teenagers, and new workers because you likely will earn more as you grow older. If you earn more later on, your tax rate will increase, by protecting those assets in a Roth IRA, you can shield them from the higher tax rates.

Roth IRA isn’t necessarily better than a Traditional IRA in all cases, it was simply better for me.

Here is another post on My Retirement Blog discussing how to choose between Roth IRAs and Traditional IRAs.