Saving for Retirement: Roth or Traditional IRA?

By Matthew Waterhouse, Intern, Shepherd Financial Partners

You have just received your first full-time job and you’re finally generating income. It is great to have money in your pocket and there are many expenses and experiences competing for your paycheck. While it may be hard to envision retirement at this point, it is very important to begin to save, even if it is just a few dollars a week. This is because money when invested, has the potential to earn returns over time and the sooner you begin saving, the more time your money has to grow. Each year’s gains can generate their own gains the next year - a powerful wealth-building phenomenon known as compounding.

What’s the best way to save for retirement? There is no definitive answer to that question as it is based upon each individual’s assessment of their situation. We profile 2 of the options, a traditional IRA or Individual Retirement Account and a Roth IRA below.

Additional Pros and Cons

Roth IRAs often help younger contributors because they are able to pay their taxes up front – when their earnings and tax rate are typically lower than in the future- and then experience tax-free growth on their contributions. When they withdraw funds, assuming they meet distribution requirements, they will have access to the full amount of money in the account – there is no tax due on money in this account.

On the other hand, contributing to a traditional IRA leaves more money in your pocket today. Provided certain income levels are met, contributions to traditional IRAs may lower your taxable income in the contribution year. That lowers your adjusted gross income, or AGI, which could help you qualify for other tax incentives you wouldn’t otherwise get, such as the child tax credit or the student loan interest deduction. A traditional IRA may also offer tax-deductible contributions for people who don’t participate in an employer-sponsored plan.

What about your tax bracket? A very important thing to consider when choosing which account to contribute to is if you expect your income tax rate in retirement to be higher or lower than what you pay now. This will determine whether the taxes you would pay today for a Roth IRA are higher or lower than what you would pay in retirement for a traditional IRA’s withdrawal.

Although it may seem logical to assume that your gross income will decline in retirement, taxable income sometimes does not. This often sneaks up on people and leaves them with less money than they actually had previously planned for. You may find that after your children are grown up and you stop saving for retirement, you lose some valuable tax deductions and tax credits, leaving you with higher taxable income in retirement.

It’s also important to examine your beliefs about future tax rates. Many economists believe federal income tax rates will rise in the future due to today’s historically low federal tax rates and large U.S. deficit — meaning Roth IRAs may be the better long-term choice if you can afford to pay the taxes now.

Conclusion

Both Traditional IRAs and Roth IRAs are great ways to plan for retirement. They have very low or no fees at all and are very practical to set up.

The important thing is to save. Many Americans defer saving until much later on in their lives, or they simply don’t understand the importance of it. Waiting even a couple years could cause you to miss out on thousands of dollars that you could have earned if you contributed to an IRA now.

Contact us for help with your retirement accounts here: http://www.shepherdfinancialpartners.com/2017539251?__hssc=209629389.4.1...

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual, nor intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor. Tax laws and provisions are subject to change.