Why the Smart Money Chooses a Roth IRA
Smart investors are opting for Roth IRAs instead of traditional IRAs
Smart investors choose Roth IRAs over traditional IRAs, according to a recent study by
"When the government creates a tax incentive, it creates an advantage for people who have the sophistication to be able to figure out the value of that incentive," says
The study used data from a random sample of 12,686 young adults who participated in the
There are many logical reasons to select a Roth IRA over a traditional retirement account. Here's a look at why sophisticated investors are choosing Roth IRAs:
Lower lifetime tax liability.
Traditional IRAs allow you to defer paying taxes on money you save for retirement until you withdraw the funds from the account. Roth IRAs permit you to pay the income tax upfront, and distributions that are made after age 59 1/2 from accounts that are at least five years old are tax-free. To decide whether you should put your retirement savings in a traditional or Roth IRA, compare your current tax rate to what you estimate you tax rate will be in retirement. If you expect to be in a higher tax bracket in retirement, it makes sense to pre-pay the tax now using a Roth account. If you think your tax rate will drop in retirement, you might want to defer paying income tax until later using a traditional retirement account. "A Roth IRA is really designed for the person who is starting out or in their younger years," says
Withdrawals from traditional IRAs become required after age 70 1/2. The penalty for failing to withdraw the correct amount is 50 percent of the amount that should have been withdrawn. Roth IRA account owners are not required to take withdrawals, which gives them more flexibility to time withdrawals or pass on tax-free money to heirs. "You don't get an immediate tax advantage with the Roth IRA, but the money that you take out during your retirement years comes out tax-free," says
Easier access to funds before retirement.
Roth IRAs give you more flexibility to make withdrawals before retirement. While traditional IRA distributions before age 59 1/2 result in a 10 percent early withdrawal penalty and income tax on the amount withdrawn, Roth IRA distributions charge the income tax and early withdrawal penalty only on the portion of the withdrawal that comes from earnings. Penalty-free withdrawals are also allowed from both types of IRAs for a variety of reasons, including college costs, significant unreimbursed medical expenses, and a first home purchase.
Leave more money to heirs.
You heirs will need to pay taxes on money you leave them in a traditional IRA. However, your beneficiaries may be able to receive tax-free distributions of money left to them in a Roth IRA.
Roth IRA conversions.
In 2012, individuals earning less than
Saving in both a traditional and Roth IRA adds tax diversification to your portfolio and allows you to be prepared for future tax-rate changes. "It allows us to essentially hedge against the risk that capital gains rates or income tax rates are going to go up in the future," says Finke. "We are taxed once on it when we put the money away and then we are allowed to defer additional taxation essentially forever."
- Why Money Really Can Buy Happiness
- 10 Things You Should Know About YourTaxes
- How to Save by Scavenging
- What's the Best Way to Give Money to Charity?
- Deja Vu? Bank of America Plans Fee Changes
- Got a Complaint About Your Bank?
- 5 Shocking Facts About Student Loan Debt
- Why the Smart Money Chooses a Roth IRA
- How to Protect Your Retirement Investments from Scams
- Smart Strategies for Taking Required Minimum Distributions
- Affordable Organic Foods for Every Budget
- Get Ready for Retirement Now
- How to Finance Life Until 100
- The Growing Challenge of Funding Retirement
- Tax Tips for Retirees
- How to Calculate Your Retirement Number
- How Long Should I Work Before Retirement?
- 10 Necessities for a Great Retirement Spot
- 10 Important Ages for Retirement Planning
- What Type of Life Insurance Do I Need?
- How to Save More Now With Savvy Budgeting
- 5 Apps for Organizing Your Expenses at Tax Time
- Banks Revamping Rewards Programs to Woo Customers
- How to Master the Art of Negotiation
- 5 Ways to Stretch Your Grocery Budget
- Sneaky Coupon Strategies Consumers Should Watch Out For
- How to Battle Shopping Addiction
- Starting Off on the Right Foot Financially
- Awkward Questions You Need to Ask Your Financial Adviser
- How to Avoid an IRS Audit
- 50 Ways to Improve Your Finances in 2012
- How to Set 2012 Money Goals That Work
- 2012: Financial Resolutions Beat Out Health and Fitness
- Time to Make New Year's Financial Resolutions
- How Retirement Savers Can Benefit from New 401(K) Fee Disclosures
- 12 Great Money Apps That Save Time and Cash
- How to Live Happily on Less
- Do You Need Longevity Insurance?
- Why Big Banks Are Like Drug Dealers
- 11 Retirement Benefit Changes Coming in 2012
- 10 Ways to Stay Safe While Shopping Online
- Take Advantage of Free Shipping Deals This Holiday Season
- Working Into Your 70s: A Smart Retirement Move
- How Co-Workers Influence Your 401(k) Choices
- How to Find the Best Bank Account for You
- How to Keep Your Holiday Spending in Check
- How To Navigate the Bank Fee Storm of 2011
- Santa on a Budget? What to Tell Your Kids
- Young Adults Suffering More Financially than Older Generations
- Borrowing From the Family Bank
Personal Finance - Why the Smart Money Chooses a Roth IRA
(c) 2012 U.S. News & World Report