There’s often a debate over which retirement fund you should choose: a Traditional or Roth IRA? As a millennial, there is a definite advantage to choosing one over the other.
You contribute to a Roth with money that has already been subject to income tax, but when you withdraw it in retirement, everything you have earned in the fund is tax-free. In comparison, you do not pay tax on Traditional IRA contributions until you take out the money in your later years. But how should you know what account will benefit you the most when you retire? If you expect to be in a higher tax bracket in retirement than you are today, contributing to a Roth IRA may be the most beneficial. If you are likely to be in a lower tax bracket in retirement, a Traditional IRA may make more sense. As a millennial who is working their way up the salary scale, you are most likely to be in a higher tax bracket later in life than you are now.
So how does that tax bracket really affect your dollars? The Roth allows you to withdraw qualified distributions free of taxes. The dollar in the Traditional IRA is subject to taxation whenever you remove it. If your tax bracket at the time of withdrawal is 25% then your Traditional IRA dollar is only worth 75 cents. The higher your tax bracket, the less your Traditional dollar is worth.
We all know that life happens, and with a Traditional IRA, you may incur penalties and taxes should you need to borrow from your retirement account. With a Roth IRA, if you need to take money from your Roth IRA, you can remove the money you have contributed, tax free. Although your IRA should be a last resort to borrow from, being able to liquify your IRA without additional taxes and penalties can be an advantage to millennials who are trying to buy a house, pay student loans, start a family, etc. and then disaster strikes.
A Roth IRA can help you purchase your first home as well as help you save for retirement. If you need funds for a down payment for your first home, you can withdraw up to $10,000 for your purchase. While its primary function is for retirement, this may be a great option for Millennials who are looking to make their first home purchase.
It can cost you less money to fund your Roth IRA now than it will in the future. Millennials who start funding a Roth IRA now, will pay less in taxes because traditionally they are making less money at the start of their career and their tax bracket is lower. As you advance in your career, you may find that you make too much to continue contributing to your Roth IRA – make sure to be aware of the new caps that are released each year. Tax laws and retirement regulations are constantly evolving, and you never know what new regulations may go into effect that could negatively impact your contributions.
Navigating through the world of retirement planning can be difficult at any age, but even more so for Millennials who are just starting their careers, families, and trying to plan for their future. A Roth IRA is a great choice for Millennials, but you should always consult your tax or financial advisor beforehand. If you’d like more information on the IRA offerings that Litchfield Bancorp offers, visit our website, stop into one of our branches, or give us a call today!
Stephen Yonych Jr.
Assistant Vice President, Watertown Manager