Roth vs. Regular IRAs: Friday Q & A

It’s Friday, so it’s time for this week’s reader-submitted Q & A. If you’d like to submit a question, click here for more information or simply email a question.

My employer does not provide a 401(k) plan. Therefore I have been looking into putting away money into an IRA. However, I’m having a good bit of trouble figuring out which plan is right for me.

Everything I read seems to provide conflicting information or information that doesn’t answer the questions I’m looking for. I am aware the contributions into the Roth are tax-deductible now. But is it true that they will be taxed when I take them out to retire? My thought is that since my tax burden isn’t too bad right now, that I would invest in a traditional IRA in order to not pay taxes later down the line. Is this assumption / thought correct?

–Tiffany D. Albuquerque, NM

STRAIGHTFORWARD ANSWER: Nope, you’ve got it backwards.

Detailed Explanation:

Somehow you’ve got the Roth and a traditional IRA definitions reversed. Here’s how they work:

Traditional IRA

1. When you make a contribution, you receive an upfront tax deduction.*
2. Until retirement, your account grows tax-deferred (isn’t taxed).
3. During retirement, you pay taxes on the amount you take out of your plan.

*Some folks with a 401(k) at work won’t get an upfront tax deduction, but Tiffany will because her employer doesn’t offer a 401(k) plan.

Roth IRA

1. When you make a contribution, you receive no tax benefit.
2. As your account grows until retirement, there is no tax due.
3. During retirement, when you may choose to take money out of your Roth, no tax is due.

So, a regular IRA offers tax-deferred growth (great) and a Roth IRA offers tax-free growth (phenomenal).

Since you believe your tax burden will be higher in the future, a Roth IRA makes a lot of sense. For most people, the only thing of greater retirement planning priority than a Roth IRA contribution is ensuring that they first take advantage of their employer match. Since you don’t have one, a Roth IRA is the likely first best step for you.

If you’re under 50, you can put in up to $5,000 each year into a Roth IRA. (Those 50+ can put in an extra grand.) Don’t wait until the next April deadline. Do it sooner – much easier to do a few hundred a month instead of coming up with a few thousand all at once.

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