Vail Daily column: Which IRA is better for younger workers?
If you’re at the beginning of your career, then you might not be thinking too much about the end of it. But even younger workers should be aware of and saving for their eventual retirement. And since you’ve got many years until you do retire, you’ve got a lot of options to consider one of which is whether an IRA may be appropriate for you and, if so, what type.
Essentially, you can choose between a traditional IRA and a Roth IRA. (Other types of IRAs are available if you’re self-employed.)
With a traditional IRA, you contribute pretax dollars, so your contributions are generally tax-deductible, depending on your income limits and whether you also have a 401(k) or other retirement plan at work. This year, you can contribute up to $5,500 to your traditional IRA, although the limit rises once you reach 50. You can fund your IRA with many types of investments — for example, stocks, bonds and government securities — and your earnings grow on a tax-deferred basis.
A Roth IRA has the same $5,500 annual contribution limit and can also be funded with many types of investments. But there are some key differences. You can only contribute to a Roth IRA if your income is below a certain threshold, but that threshold is quite high, especially for younger workers starting their careers. So you’ll likely be eligible. However, your contributions are never tax-deductible, so you’re basically funding your Roth IRA with money on which you’ve already been taxed. But your earnings can grow tax free, as long as you don’t start taking withdrawals until you’re 59½ and you’ve had your account at least five years.
The big decision
Assuming you can contribute to either IRA, which should you choose? There’s no one right answer for everyone, but as a younger worker, you may be able to gain two important benefits from contributing to a Roth.
First, since you’re probably earning much less now than you will later in your career, you’re likely in a relatively low tax bracket. So it may make sense to pay income taxes now on your Roth contributions, rather than pay the taxes later on withdrawals from a traditional IRA. And second, a Roth IRA may provide more flexibility than a traditional IRA. Usually, the only way to get money from a traditional IRA before you retire is through a short-term loan; otherwise, you can get hit with both taxes and penalties on early withdrawals. But with a Roth IRA, you can withdraw your contributions (not the earnings) penalty free to help pay for your first house or to go back to school.
Still, as mentioned above, there’s no hard-and-fast rule as to which IRA is better for younger workers. For example, if you are certain you’ll be in a lower tax bracket when you retire, then you might be better off by taking the yearly tax deductions from your traditional IRA and paying taxes on the withdrawals when you retire. But that’s a hard prediction for anyone to make.
Your tax advisor may be able to provide some guidance on which IRA is better for you — but either one can be a valuable resource for that day when you say “goodbye” to work and start a new phase of your life.
This article was written by Edward Jones for use by your local Edward Jones financial adviser. Edward Jones and its associates and financial advisers do not provide tax or legal advice. Chuck Smallwood, Bret Hooper, Tina DeWitt, Charlie Wick, Chris Murray, Kevin Brubeck and Dolly Schaub are financial advisers with Edward Jones Investments. They can be reached in Edwards at 970-926-1728 and in Eagle at 970-328-4959 and 970-328-0361.