Whether you have a 401(k) or similar retirement plan at work or you want to save for retirement on your own, you will be looking at an IRA. There are two main varieties—traditional and Roth, and The Motley Fool's "8-Point Checklist for Choosing a Retirement Plan" provides some questions to ask that may make the decision easier.
- When do you want to pay taxes? True, no one really wants to pay taxes; however, when you are saving for retirement, you get to make a choice. This is the most significant difference between the two main types of IRAs. You may be able to qualify for a tax deduction for your contributions with a traditional IRA, but when you do withdraw the money in retirement, it's taxed as ordinary income. However, Roth IRA contributions aren't deductible on your current tax return, but withdrawals after you retire are going to be tax-free. So, ask yourself when you'd like your tax break—now or later?
- Will you need the money soon after you retire? With pre-tax retirement plans such as the traditional IRA or many of the employer-sponsored retirement plans, you must begin taking distributions after age 70½. Once you reach that age, you'll have to withdraw a certain percentage of your account's value every year, based on IRS life expectancy tables. However, a Roth IRA doesn't have this requirement. You can leave the money in the account alone as long as you like. If you don't need to use it until you're 75, 80, or even 90, that's OK. Because of this, Roth are thought to be the best option for estate planning.
- Do you want early access to the money? With either IRA, making an "unqualified" withdrawal means a 10% penalty. There are certain exceptions, like the ability to use IRA funds for college without a penalty at any time. Roth IRAs also let you withdraw your original contributions—but not investment profits—for any time and for any reason. Because of this, a Roth IRA can be both a retirement account and an emergency fund.
- Do you want to be able to contribute after you retire? Roth IRAs don't have an upper age limit for contributions, and you can contribute as long as you have earned income—no matter how old you are. With both account types, there's no lower age limit—provided the earned income requirement is satisfied.
- Do you want to leave some of your retirement savings to your heirs? Roth IRAs are super tools for estate planning. Since you've already paid taxes on your contributions, the money in your account can be left to your heirs tax-free.
These are some of the considerations when deciding which IRA is the best for your retirement. But there's no best option for everyone. It depends on which features appeal to you the most.
Reference: The Motley Fool (April 17, 2016) "8-Point Checklist for Choosing a Retirement Plan"