Roth vs Traditional IRA

When you start to think about investing in an independent retirement account you have one big initial decision to make before things can go forward and to help with that you need to look at Roth vs traditional IRA options.

Independent retirement accounts are basically the same in most areas. You invest a portion of your income into an account that will be invested in various ways (stocks, bonds, money market accounts) of your choosing. Whereas with a 401k everything is set up through your employer, with an independent option you go out and find a company that you would like to handle things for you and set everything up on your own there. You have a lot more control of your savings in this situation.

The first place where you exercise this control is in choosing your type of account. This decision will mostly affect your taxes, but now and in retirement, and should be considered carefully.

With a Roth IRA your contributions are taken from your income after taxes are taken out. This means that when you retire you don't have to pay taxes on this income (because you already did) and your taking care of your tax obligations now. It also means there are less strict rules about early withdrawals.

With a Traditional IRA things are done much more similarly to a traditional 401k. Your contributions are taken from your income before taxes are taken out. This means that some of the money you would have been spending in taxes is now being invested in your retirement savings. Over the years this money will earn you returns and help grown your savings. When you go to make withdrawals in retirement you will then have to pay taxes on this income. There are very strict rules about taking early withdrawals from these accounts, if you do so you will have to pay both taxes and a ten percent early withdrawal penalty.

Deciding on which way to go here can be difficult and is really an individual decision. A lot of people decide based on what they think their income level will be in retirement versus now. This is because your income level decides what percentage of your income goes to taxes (the higher your income the higher percentage you pay in taxes), so if you're income is going to be less in retirement then you go with a traditional IRA and end up paying less in taxes overall. This is always a guess, however, and there may be other circumstances to consider in your situation. Some people like to hedge their bets a little and invest in both a traditional 401k and Roth IRA to spread out their tax obligations.

If you're looking at Roth vs traditional IRA options and wondering how you'll ever decide you can always consult a financial professional, have them look over your finances and get their opinion on what it is you should do. Remember, however stressful this decision may seem, that there is no wrong answer. You are saving for retirement either way, and that's really the goal here.