How is the Roth IRA different from the regular IRA, and how can it change the game in retirement? Many people have heard of a Roth IRA but how is it different from the regular IRA? Let’s get into it.
The main difference between a regular IRA and a Roth IRA is when you pay taxes. For a regular IRA, your contributions are tax deductible and you don’t pay any taxes until you pull the money out (usually during retirement). For Roth IRA, your contributions are not tax-deductible when you put it in but you will never pay taxes on that money (or the money that money makes you).
For example, if you invest $100 into your normal IRA, the $100 would be tax deductible. But come retirement time, let’s say that $100 has turned to $300 because it was invested. You would pay taxes on the the full $300.
Let’s use the same example but with a Roth TSP. You would pay taxes on the $100 in the year that you made it. But come retirement, you would be able to take out the entire $300 without paying a penny in taxes.
Now, the million dollar question. Which is better?!? Like always, It depends. Most people believe that they will be in a lower tax bracket while in retirement so they’d like to push their taxes (using a regular IRA) until they pull their money out. What I have seen is that many people are not in a lower tax bracket because nearly all of their income in retirement (even a good portion of their social security if they make over certain amounts) counts as taxable income. Some of the only ways to ensure that you will be in a lower tax bracket in retirement is by living on less (which can be no fun for obvious reasons) or by having savings in a Roth account. Because distributions from a Roth IRA are completely tax free in retirement, you can take out as much as you’d like and it won’t affect your tax bracket.
For most people it makes sense to use both a regular IRA and Roth IRA. Let me explain why. It is almost impossible to predict what taxes will be like in retirement. Tax rates can change and your personal situation can change from year to year. Having both a regular IRA and Roth IRA gives you the flexibility to adjust where you take your money from year by year. If you have a year with higher income than expected, you can withdraw from the Roth IRA to limit your taxable income that year. Furthermore, if taxes decrease or you have less income one year, you can withdraw from the regular IRA.
Obviously there are many rules for how these accounts can and can not be used. Make sure to educate yourself on the pros and cons of each so that you can make an informed decision for your personal situation.
There are also Roth 401(k), Roth 403(b), and Roth TSP options for those that have retirement plans through their employers. These plans work in a similar way as Roth IRA’s but with small variations depending on the type of plan.
Having both a regular IRA and a Roth IRA gives you the ability to be flexible in retirement and to take advantage of opportunities that might arise along the way. And when it comes to retirement, having options can make a huge difference in what kind of life-style you are able to lead.