roth

[totient]

I was in the bank this morning depositing a couple of checks and picked up a copy of their little newsletter to read while waiting in line. These newsletters don't often have much to say and it seems like every one tries to explain the difference between Roth and traditional retirement savings. This one explained the history of the Roth IRA and its extension to 401(k)s, explained why Roth 401(k)s were not commonly offered until a little while after their introduction, and then did the usual thing of going through how they're treated totally differently for tax purposes but wind up being a financial wash for most people. Then the article attempted to give circumstances why you might want one or the other... and like most such articles, totally missed the biggest real reason anyone would want to choose one or the other.

By now you've either stopped reading or are wondering what that reason is, so:

Roth retirement plans have a 25% larger effective contribution limit.
Traditional retirement plans allow you to catch up on that 25% later tax-free, possibly all at once.

If you're contributing enough money that you're bumping up against the $15,500 limit, use a Roth.
If you're not and there is *any* chance you might ever come into a windfall (like an inheritance) that you'd like to be able to invest in a tax-advantaged way, use a traditional IRA (or 401k).

When that windfall comes (or perhaps in the following tax year, if it's a taxable windfall), convert the traditional retirement plan to a Roth. The conversion is a prepayment of all the taxes that will ever be due on that money -- but it has the effect of making all the income on the retirement money tax-free going forward, so it's a great investment. And the tax payment doesn't have to come from the IRA; it can come from the windfall.

Comments

[kissoflife.livejournal.com]

_That_ was very useful. Thank you.

[chenoameg.livejournal.com]

Another good reason to choose a Roth is if you aren't sure you have the money to put away for retirement.

You can withdraw your contributions at anytime with no penalty. So you can make the deposit (take advantage of the saver's credit if you're eligible), and then have it be your emergency fund. If nothing bad happens you're already started on your retirement savings.

I know this is true for IRAs, I do not know about 401ks.

[muffyjo]

I need to sit down with you sometime and pick your brain about stuff like this. It would be really helpful to understand. This, alone, was helpful but made more questions in my head. I'll take it up with you offline.

[miss-chance.livejournal.com]

would you like some cookies?