Roth IRAs also carry an opportunity cost risk. Your contributions can be withdrawn at any time, but not your investment income, buying a home or investing in real estate, contributing to an employer-sponsored plan such as 401 (k), investing additional funds in a brokerage account. Customers should know that unlike a traditional IRA, which provides a specific immediate benefit, the benefit of a Roth IRA may be zero. The biggest risk of a Roth IRA, however, is that the present value of the prepaid tax could be higher than the present value of future tax savings.
Founded in 1993 by brothers Tom and David Gardner, The Motley Fool helps millions of people achieve financial freedom through our website, podcasts, books, newspaper columns, radio shows, and premium investment services. There’s a lot to consider Deciding between a traditional IRA and a Roth IRA is tough, and it’s likely that what works best for one investor may not work best for another. Investors must not only consider these drawbacks of the Roth IRA, but also consider whether or not they are likely to be in a higher or lower income tax bracket in retirement. If a higher income tax bracket is expected, the tax-free withdrawals and potential benefits may be more valuable to heirs to a Roth IRA.
However, if a lower income tax bracket is likely in retirement, a traditional IRA may be best. There are a few things you need to know, particularly positive and negative tax effects, if you’re considering a Roth IRA. A Roth IRA is an individual retirement account (IRA) that allows you to contribute money to your retirement savings after tax. However, you may have other financial priorities, such as paying off high-interest debt, that are more urgent than maxing out your Roth IRA.
Here are three issues with Roth IRAs that could mean it makes more sense to use a traditional IRA instead. However, investors who don’t expect to live long enough to withdraw their Roth IRA balance can still decide that Roth IRAs are the best option for transferring assets to heirs. Roth IRAs offer a long-term tax advantage because deductions from contributions and investment income are not taxed in retirement. Investors should remember, however, that traditional IRA contributions offer a tax deduction and not a tax credit, so it’s not a one-to-one dollar comparison between the potential tax savings of a traditional IRA and the tax payments required by a Roth IRA.
The second risk is the possibility that money from a Roth IRA distribution may not be taxed at all if the total amount of income combined with other income has not reached a taxable level. Also note that a Roth IRA is simply a tax-advantaged account in which you invest. Investments involve risks. That means you withdraw your Social Security and then take some money out of your 401 (k) or traditional IRA, just enough to hit the top of your income tax bracket. Income limitsToo high an income is a good problem, but not if you’re hoping to salt away money for retirement with a Roth IRA.
There is a tricky but completely legal way for high-income earners to contribute to a Roth IRA, even if their income exceeds the limits. While the benefits of Roth IRAs are remarkable, they don’t necessarily mean that Roth is the best choice for everyone.
