A Roth IRA or 401 (k) are the most sensible if you're sure you'll have a higher income when you retire than you do now. If you expect your income (and your tax rate) to be higher today and lower in retirement, a traditional IRA or 401 (k) is likely to be the best option. Let's say you're eligible for both a Roth account and a traditional IRA. You usually do better in a traditional version if you expect to be in a lower tax bracket when you retire.
By deducting your contributions now, you reduce your current tax bill. When you retire and start withdrawing money, you'll be in a lower tax bracket, which will give the tax collector less money overall. If you expect to be in the same tax bracket or higher when you retire, you may want to consider contributing to a Roth IRA, which allows you to settle your tax bill now and not later on. The classic 401 (k) plan offered by most employers offers the same tax benefits as a traditional IRA.
A Roth IRA can offer flexibility to manage your taxes and expenses during retirement because you can withdraw money without increasing your tax bill, which could be useful if, for example, you have to make a significant and one-time expense after you retire. Many people make their IRA contribution just before the tax deadline and after they have determined their MAGI for the fiscal year, and deposit the contribution into a money market fund. But eventually you'll have to face that tax burden when you retire, which means that unless you really need that initial tax break, it's hard to go wrong with a Roth IRA. If your tax rate is lower now than when you started withdrawing funds, you can maximize your tax benefits by making a contribution to the Roth IRA this tax year and receiving tax-free withdrawals in the future, as long as you meet the eligibility requirements.
A traditional IRA is an individual retirement account that allows you to make pre-tax contributions (if your income is below a certain level) and not pay taxes until you withdraw the money. If you don't qualify for a Roth IRA due to income limits, some investors choose to make contributions to a traditional IRA and then convert them into a Roth IRA. Roth IRA conversions require a five-year retention period before earnings can be withdrawn tax-free, and subsequent conversions will require their own five-year retention period. Contributions to these types of accounts can be made before taxes, unlike IRA contributions that are made after tax.
For example, with a combination of savings from a traditional IRA and a Roth IRA, you can withdraw distributions from your traditional IRA until you reach the top of your income tax bracket and then withdraw everything you need beyond that amount from a Roth IRA, which is tax-free, provided certain conditions are met. Of course, on the other hand, tax savings may offer an additional incentive to save now that Roth IRAs don't offer. If you change jobs, you have the option of converting a traditional 401 (k) directly into a Roth IRA without having to convert it into a traditional IRA first. Both traditional and Roth IRAs are great long-term savings tools, so learn about the differences and make an informed decision that fits your retirement goals.
Taking money out of your Roth IRA means you may lose the ability to accumulate retirement earnings. The traditional IRA deductibility is only restricted if you or your spouse have access to a work-savings plan, such as a 401 (k). .