Tax Season Dilemna: Invest Money in a Traditional IRA or a Roth IRA?
By Chris Chen CFP | Financial Planning , Retirement Planning
Invest in a Roth IRA or a Traditional IRA?
In a traditional IRA, your contribution will be deductible from your taxable income, and will grow tax-deferred . Income taxes will be paid when you take distributions at retirement. The immediate benefit is that a contribution will help you reduce your taxable income, and, therefore, your taxes. (For the 2012 tax year, you have until April 15 to make that contribution.)
For a Roth IRA, your contribution is not tax deductible . However, it will grow tax free, and distributions in retirement will not be taxable. Hence, your retirement income from the Roth would be tax-free.
The traditional IRA helps you save on taxes now , and the Roth IRA helps you save on taxes later . What then should you do: save on taxes now or save on taxes later?
The answer is entirely about what you expect your taxes to be when you retire. If you expect your tax rate to be lower in retirement than today, you may want to consider a regular IRA. That is because, you will be saving a relatively large amount in taxes today, and paying at a relatively low rate in retirement.
On the other hand, should you expect your tax rate to be higher in retirement than today, you may want to consider a Roth. That is because you would be paying at a low tax rate today, and saving even more taxes later on.
So, you might ask, how can you figure out what your tax rate will be in retirement? That is a different question altogether!
Check out out other retirement posts:
Is the new tax law an opportunity for Roth conversions
Rolling over your 401(k) to an IRA
7 IRA rules that could save you time and money
Doing the Solo 401k or SEP IRA Dance
Roth 401(k) or not Roth 401(k)