Is a Traditional IRA Really the Wrong Way to Invest For Retirement

Suze Orman, a personal finance superstar, advises retirement savers to avoid conventional accounts in favor of Roth accounts, particularly during this worldwide pandemic. That advice, like everything else in personal finance, is highly dependent on the individual.

Orman noted in an interview with the “Pivot” podcast that investors should consider the tax implications of keeping with a traditional-style plan like a 401(k), 403(b), or individual retirement account. Traditional accounts are funded with pre-tax funds, whereas Roth accounts are supported with post-tax funds. Traditional account withdrawals are taxed at the time of distribution, but Roth account withdrawals are tax-free.

What is the Distinction Between a Traditional 401(k) and a Roth 401(k)?

“Do you honestly believe that tax brackets won’t have to rise in five, ten, or fifteen years to pay off the debt we’re carrying?” said Orman. “Of course they’ll have to.” 

She advised during her conversation that people should rush to Roth accounts to take advantage of what she called “the lowest tax levels” that Americans will see for a long time.

Orman’s advice can be contentious at times, such as when she urged that individuals give up to-go coffee if they ever want to retire comfortably. The issue with this specific piece of advice, according to Monica Dwyer, vice president of Harvest Financial Advisors, is that it is too broad. 

“I believe Suze is afraid that future taxes will be substantially higher, because we cannot continue on our current spending spree; our deficit is increasing, and this debt, like someone with a lot of credit card debt, will have devastating implications at some time,” said Dwyer. “Does this imply that her advice is sound? Certainly not. It all depends on the individual.”

Giving general financial advice is always difficult, according to Dennis Nolte, vice president of Seacoast Investment Services. Different accounts serve different objectives and are typically integrated into bigger retirement savings and spending plans. He stated that younger individuals, who are normally in lower tax brackets while starting their careers, gain from Roth accounts while middle-aged adults in their prime earning years profit from regular accounts.

Even with the greatest intentions and preparations, it’s difficult to predict what the future contains. 

“We’d simply be able to estimate whether contributing to our 401(k) on a pre tax or Roth basis was optimum if we had perfect knowledge about our career trajectory, future earnings, and future tax rates,” said Roger Ma, a financial consultant at lifelaidout. “Unfortunately, none of that information is available to us.”

Financial advisors discussed the advantages and disadvantages of Roth vs. regular accounts as well as what consumers should consider when choosing between the two.

Why the Roth IRA is a Good Option For Most Savers

For individuals who qualify, there are several reasons why a Roth IRA may be preferable to a standard IRA. 

1. With a Roth, early withdrawal requirements are significantly more flexible. 

Although early withdrawals from retirement accounts are normally discouraged, the Roth permits you to take contributions — money you put into the account rather than profits — at any time without paying income taxes or incurring an early withdrawal penalty.

If you take money out of a regular IRA before you retire, the IRS isn’t as forgiving. You’ll almost certainly be hit with a 10% early withdrawal penalty and will owe taxes on the money you take out at your current tax rate. There are a few exceptions to this rule. For more information, check our page on conventional IRA withdrawal requirements. Regardless, you’ll need to approach with far more caution than you would with a Roth.

2. For retirees, the Roth has fewer limitations. You must begin taking required minimum distributions (RMDs) at the age of 72 if you have a traditional IRA.

Unless you inherit a Roth IRA, there are no mandatory minimum distribution rules. You have the option of leaving your savings in the account to grow tax-free for as long as you live.

3. You’ll wind up with more after-tax money in a Roth IRA unless you’re an incredibly careful saver.

Yes, both forms of IRAs have tax advantages. But there’s an often-overlooked advantage to the Roth’s tax-deferred structure — you won’t be tempted to squander your tax cut before retirement through tax-free withdrawals. The tax advantage from a conventional IRA is provided annually when you file your taxes, making it easy to spend the money on whatever you want.

You must be disciplined enough to invest the typical IRA tax savings you receive each year back into your retirement savings in order to break even in terms of after-tax savings. If that seems doubtful, you’d be better off investing in a Roth where you’ll have greater after-tax savings when you retire.

4. Investing in a Roth with your 401(k) provides tax diversity. 

Most companies’ regular 401(k) plans give the same tax advantages as a traditional IRA. Although some employers provide a Roth 401(k) plan, not all do. If yours does not, putting part of your retirement assets into a Roth IRA will give you more alternatives for reducing your tax burden in retirement.

On top of all of this, you might want to check out SEP IRA contributions.

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