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TO ROTH, OR NOT TO ROTH? THAT'S A GOOD QUESTION!  

FEBRUARY, 2013

Having grown up in the 80’s and working in financial services and education, when I hear “IRA” I find myself vacillating between the Irish Republican Army (IRA) and the Individual Retirement Account (IRA). So if this distinction alone confuses you, know that you’re not alone. But more importantly, when it comes to saving for retirement knowing the basic differences between a “Roth” IRA and a “Traditional” IRA is much more critical.

The Individual Retirement Account (IRA) is open to any individual to save for retirement. Similar to a 401K plan offered by an employer, the Traditional IRA offers you a chance to put away money from your paycheck PRE-tax. This money then grows over time in investments of your choosing, and when you retire the money is distributed to you and is THEN taxed as income. The Roth IRA is a mirror image in that you contribute money to it from out-of-pocket, in other words POST-tax dollars. The money in a Roth IRA grows over time and when you retire the money is distributed TAX FREE since you already paid tax on those dollars when you originally earned them.

The advantage of the Traditional IRA is that you can contribute money today and lower your current tax burden. In fact, you will typically need to contribute more than 3% of your pay before you really notice a difference in your take home pay. So, why on earth would you NOT want to save this money? If you have a 401K (an employer sponsored retirement savings plan), the same is true as it works under the same principles but could be even sweeter if your employer offers any kind of matching contributions. Most do, and the match they offer is typically between 3-6% or more. That is “free” money which over the course of a career could REALLY add up! There are some basic assumptions with the Traditional IRA. You are assuming that you will be making LESS money after age 70, thus placing you in a lower income tax bracket upon retirement. But if you do not retire, you may be forced to take distributions and thus add to your income and pay a higher tax on the money you’ve been saving all these years.

The advantage of the Roth IRA is that you can bet on tax rates NOT going to be lower upon your retirement. Should you still be earning a decent income, Roth IRA money can be distributed entirely tax free and not affect your current year’s income. The interest earned throughout the life of a Roth IRA is also tax free which can add more bang for the buck over the course of the investment. My personal belief is that government will only be getting bigger and more expensive as the years go by, so don’t expect tax rates to come down any time soon! The Roth is your best bet to hedge against this, a bet I personally am taking. I love the concept of the Roth for as the markets gain I’m not earning money for the government.

So which IRA plan is for you? Well, how should I know? Most experts would probably say that for most people, a combination of both is best. If you already participate in a 401K plan, open a Roth IRA and save even more there. If you leave your employer, that 401K can be rolled into a Traditional IRA thus giving you perhaps a wider menu of investment options.

When it comes to the investments themselves, do not fear. Most companies now offer “Age-based” options which are basically like “Investing for dummies” (something I have found often out-performs most of my other funds). Consult a trusted advisor, but pay attention to loads and fees. There are better deals online and for do-it-yourself investing, but always be attentive to your potential risk. The Age-based funds reallocate the money from higher risk to more conservative funds over the course of your work career, thus helping to prevent any sort of drastic loss just prior to your retirement (that would REALLY not be a happy day!)

IRA’s, of course, include restrictions such as income limitations, contribution limits, and whether or not you also contribute to an employer plan. Lawyers, doctors, and other professionals may simply earn too much money to contribute to an IRA. But these folks should check out my thoughts on Health Savings Accounts (HSA’s) as a retirement savings vehicle.

All in all, the best advice I have about saving for retirement is to start early, save as much as you can with a minimum target of 10% of your income, NEVER touch your savings, and diversify your investments and your investment vehicles. Lastly, if your retirement plan consists of buying lottery tickets and expecting Social Security to take care of you, keep dreaming. So, to Roth or not to Roth? To which I answer, YES!