Is a Roth IRA right for you?

Key takeaways

• Traditional IRAs provide you with tax advantages now when saving for retirement, Roth IRAs give you advantages later.
• Roth IRAs offer the potential for your investments to grow tax-free.
• You can withdraw your contributions to a Roth IRA at any time with no penalties.

What is an IRA?

IRA stands for “individual retirement account,” meaning it’s an investing account you can open yourself (as opposed to something like a 401k that might be offered through your employer) to start setting aside money for retirement. IRAs offer tax advantages that you won’t find with other methods of saving and investing.

IRA basics

Two of the most popular types of IRAs are traditional IRAs and Roth IRAs. When you put money in a traditional IRA it’s generally tax-deductible—meaning you don’t have to pay any taxes right now on the money you contribute (instead you do it later when you withdraw the money in retirement). When you contribute to a Roth IRA it’s not tax-deductible, but you can withdraw it tax-free when you retire.

Example: If you make $50,000 this year and put $5,000 in a traditional IRA, you pay taxes on an income of $45,000. But if you contribute $5,000 to a Roth IRA, you still pay taxes this year on an income of $50,000.

Pay taxes now or later?

At the highest level, the big difference between these two kinds of IRAs is whether you pay taxes on your contributions now (Roth) or when you retire (traditional). So, why would you want to pay taxes now on the money you’re saving for retirement?

One thing to consider is what your tax rate is currently compared to what it may be when you retire.

Example: Someone early in their career might expect to be in a higher tax bracket when they retire, so it could be beneficial in the long run to pay taxes on their IRA contributions now at a lower rate.

Advantages of a Roth IRA

Beyond possibly taking advantage of a lower tax rate, there are some other very appealing potential benefits of putting money in a Roth IRA.

Tax-free growth: Since the money you contribute to a Roth IRA has already been taxed, you don’t need to pay any taxes when you withdraw it. This also applies to any additional earnings it may make, which could be a substantial amount of tax-free income for you in the long run.

Example: Let’s say you contribute $5,000 this year to a Roth IRA. If in 20 years that $5,000 grows to $15,000, the additional $10,000 is money you don’t have to pay taxes on.

No penalty for early withdrawals of contributions: A Roth IRA also allows you to withdraw the money you’ve contributed at any point with no penalty (there are rules about withdrawing earnings though). So in the example above, if you need that $5,000 before retirement you can take it out whenever you like.

Roth IRA pros and cons

To summarize, here are a few basic pros and cons of a Roth IRA compared to a traditional IRA.

Pros

Potential to invest and make money tax-free: With a traditional IRA you have to pay taxes on your earnings when you withdraw the money in retirement, but with a Roth IRA you don’t.

Flexibility: A Roth IRA lets you withdraw your contributions at any time with no consequences, but with a traditional IRA there may be added tax penalties for taking your money out before you’re 59½ years old.

Cons

Less money in your pocket today: Since you pay income taxes on what you contribute to a Roth IRA, you’ll have less money available right now than if you contributed the same amount to a traditional IRA.

Income can be too high for a Roth IRA: If you make over a certain amount of money, you may not be allowed to contribute to a Roth IRA. There are no income limits for a traditional IRA (although there are for it to be tax-deductible, these amounts are subject to annual cost-of-living adjustments).

Next steps to consider

If you’re over 18 and under the maximum income limits, you’re allowed to contribute up to $6,500 to a Roth IRA for 2023.

Plynk does not currently offer retirement accounts, but we are continually evaluating new enhancements to our app.