Is a Roth IRA the Best Savings Vehicle for you?

edralyn
April 5, 2013

If you have a bit of cash saved up and are looking to invest it to start preparing for your future, you’ve probably heard about Roth IRAs. They’ve become very common, and for many people, they’re a great choice when it comes to saving up money for retirement. Still, it’s important to know the advantages and some of your other options before you put your money into one.

What is an IRA?

IRA stands for Individual Retirement Account. Essentially, it’s a savings account you create that is specifically geared towards saving for retirement. The withdrawal age without penalty is 59 ½, which means that you can’t take out the money you put in (except for certain circumstances, which are discussed below). These accounts come with tax breaks, which helps you save money on your investment. Usually, the money within the IRA is put into stocks, bonds, or other common investment options, and that’s how you earn money within the account.

Roth IRA vs. Traditional IRA

The biggest difference between a Roth and a Roth IRA involves taxes. Essentially, with a traditional Roth, you pay taxes when you take out the cash, whereas with an IRA, you pay taxes on the money first and take it out tax-free, including the earnings, later. The biggest reason to choose one over the other has to do with your tax bracket. If you’re making a lot of money now and are in a high tax bracket, a traditional Roth might be better, even though you’ll be taxed on your earnings when you withdraw it. Further, Roth IRAs have income limits for contributors, so if you’re making too much, you won’t be able to open one. If you’re in a low tax bracket, however, which is especially common with younger savers, a Roth IRA can be a great way to save money in the long run and avoid costly taxes on your cash later.

Early Withdrawals

One big advantage to a Roth IRA is that you’re allowed to take out your contributions (not the earnings) at any time without penalty, even before the 59 ½ withdrawal age. You should avoid doing this if possible, since it reduces the amount of interest you will earn, but it’s useful if you have an emergency or an important reason to take it out.

Another way to withdraw your money from a Roth IRA early is to purchase a house. MSN money explains, “You can withdraw all of your contributions and up to $10,000 of earnings to buy your first house, tax- and penalty-free, once the account has been open for at least five years.” If you’re young and worried about putting money into retirement savings because you won’t have access to that cash, or its earnings, a Roth IRA is a good choice when you want to use that money for a down-payment.

Other Investing Choices

There are hundreds of other investing choices, including real estate, a 401k, peer-to-peer-lending, etc. Be aware of the financial opportunities around you before dumping everything you have into a single retirement vehicle – for example, many employers to a partial or full match if you contribute to a 401k, which is a huge advantage. You can also look into rolling these different accounts into each other when it’s most advantageous (which is a great way to get out of paying large amounts of taxes on cash).

Roth IRAs are a simple choice for most people who are starting to save for retirement and are in a low tax bracket, but every person’s situation and goals are different, and you need to do what works for you.

Lindsey Grant is an avid blogger. Click here to find financial calculators like this one to help you figure out how much to deposit into an IRA.