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What You Should Know: Roth IRA Edition

401k at-home bank banking budgeting business facts investing money roth ira savings Jan 14, 2021

Just because you're young, doesn’t mean you can’t save for your future. Taking small steps such as opening up a Roth IRA can lead to big savings. If you're wondering how to choose between a Roth IRA and a 401k, or even an IRA with a different retirement plan, here are 5 steps to help you decide. It’s important to compare how the two retirement plans, Roth and 401k, differ and how they differ from others. 

  1. The IRA you choose comes down to whether you want to pay tax on the contributions you make today or wait until you have paid tax on withdrawals. If you deduct your traditional IRA contributions and then decide to convert your traditional IRA into a Roth IRA, you will have to wait a few months before you pay taxes on your assets before tax is paid. You can avoid tax if you swap your pension account for a regular IRA or traditional IRA. So if you choose between a Roth IRA and a traditional IRA, which one is the best? If you think a Roth IRA is the best retirement savings vehicle for your goals, you can open an account right away. If you meet the above "Roth IRA rules.”
  2. Whether you are a Roth IRA or a Traditional IRA, the money you contribute has the potential to boost income - tax-free. If you make enough money to contribute to the IRA but have no money in an IRA and want to put money into an IRA this year, you can use a back door strategy of the "Roth IRA." With a traditional version of the same account, your income will be just as good, if not better, than your income tax rate. The only limit to which money can be paid into Roth IRAs is the income limit that is exceeded by the income, not the total number of years of earnings.
  3. A back door is when you open a traditional IRA and it rolls into a Roth IRA later. By first contributing to a traditional IRA and then converting it to a Roth IRA, you create a "back-door Roth" for yourself. If you want to open a Roth IRA but are not eligible to contribute because your income is too high, you can do the Roth maneuver through the back door. If it turns out that you made too much money before the Roth IRA was established, you can convert all the assets of your traditional IRA into Roth. You can do this "back-door Roth" maneuver even if you don't have to "open" your Roth IRAs. 
  4. If you ever have a big emergency and need money, it's much easier to tap into your Roth IRA than tap into a 401k or traditional IRA and pay a 10% penalty. If you decide to save into a Roth IRA or save nothing at all and fund your 401 (k), you are saving more than you should. This can mean that you have more money in your IRA than in your 401 (k) (or other traditional) IRA. 
  5. One of the reasons a Roth IRA is a better choice for teenagers is that withdrawals are not taxed as if they were in a traditional IRA. If you have a 401 (k), you can still make the maximum contribution allowed, but you will have to pay tax on the money you convert from a traditional IRA to a Roth IRA. If your income is below the IRS income limit, no tax will be due on contributions to your Roth or 401 (k) because you are not eligible for a Roth IRA as long as your income is below the tax threshold. You can have both a traditional IRA and an IRA, and remember that contribution limits apply to both IRA accounts as a whole. 

If you are a young worker in the early years of your career, the chances that you are better off with a Roth IRA than with your Roth 401 (k) are overwhelming, but given that pension, accounts are taxed differently, how do you know if it's the right choice for you? If you think your tax rate is lower now than it was in retirement, it might make sense to have a ROTH IRA. However, if you are a younger worker earning now, rather than in your late 20s or early 30s, a tax-free retirement account such as a traditional IRA account or 401 (k) account may be the most useful.