Younger people tend to be in a lower tax bracket now than they'll be in retirement, which is one reason why Roth IRAs are ideal for Millennials. Roth IRAs don't get the same upfront tax break that traditional IRAs do. But you won't owe taxes on any earnings in the account, or on qualified distributions.
401(k)s and IRAs
Most financial experts tell young people to use a Roth IRA instead of a traditional IRA because while you don't get a tax benefit from your contributions, both they and everything they earn will grow tax-free until retirement and you won't pay any tax on withdrawals.
With a Roth IRA, you contribute after-tax dollars, your money grows tax-free, and you can generally make tax- and penalty-free withdrawals after age 59½. With a Traditional IRA, you contribute pre- or after-tax dollars, your money grows tax-deferred, and withdrawals are taxed as current income after age 59½.
But when you're earning a lot of money, a Roth IRA could actually hurt you. You will likely be in a higher tax bracket and you'll pay more money to the government this year than you would have needed to if you'd used a tax-deferred account, like a traditional IRA.
Yes, if you meet the eligibility requirements for each type
You may maintain both a traditional IRA and a Roth IRA, as long as your total contribution doesn't exceed the Internal Revenue Service (IRS) limits for any given year, and you meet certain other eligibility requirements.
Key Takeaways
Roth IRAs offer several key benefits, including tax-free growth, tax-free withdrawals in retirement, and no required minimum distributions. An obvious disadvantage is that you're contributing post-tax money, and that's a bigger hit on your current income.
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In general, if you think you'll be in a higher tax bracket when you retire, a Roth IRA may be the better choice. You'll pay taxes now, at a lower rate, and withdraw funds tax-free in retirement when you're in a higher tax bracket.
The easiest way to escape paying taxes on an IRA conversion is to make traditional IRA contributions when your income exceeds the threshold for deducting IRA contributions, then converting them to a Roth IRA. If you're covered by an employer retirement plan, the IRS limits IRA deductibility.
The first five-year rule states that you must wait five years after your first contribution to a Roth IRA to withdraw your earnings tax free. The five-year period starts on the first day of the tax year for which you made a contribution to any Roth IRA, not necessarily the one you're withdrawing from.
But there's a workaround: A Roth IRA conversion allows you, regardless of income level, to convert all or part of your existing traditional IRA funds to a Roth IRA.
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