Alamy Many financial advisers believe that Roth individual retirement accounts are the best way available for you to save for retirement. With income tax rates having gone up in 2013 and with further increases potentially on the horizon, a retirement account that promises tax-free treatment not only while your money is invested within the account but also when you decide to make distributions is extremely valuable.
Yet choosing a Roth IRA over other retirement-saving choices comes at a cost — and for many taxpayers, it’s too high a price to pay.
Your Tax Rate Isn’t Going to Get Any Higher
The general idea behind a Roth IRA is that by making after-tax contributions, you get the benefit of tax-free growth throughout your career and tax-free withdrawals in retirement. But the tradeoff is that you give up the potential deduction you might be eligible to receive by making contributions to a traditional IRA or 401(k) account.
Whether that tradeoff is worth it depends on several factors, but the most important compares your current tax rate with what you expect to pay after you retire.
If you’re in the prime of your career and have earnings that put you in the maximum tax bracket, the value of getting a tax deduction on traditional retirement-account contributions is extremely high. So using a Roth and giving up that deduction doesn’t make much sense. For those who are just getting started and are in low tax brackets, it’s a lot easier to justify giving up a smaller deduction now in exchange for big tax savings later.
Your Employer Gives You a Better Deal
Roth IRAs don’t offer one thing that many workers get from their 401(k) plans: matching contributions from their employers.
If you only have a limited amount to save for retirement, your first priority should generally be to contribute to your workplace 401(k) at least to maximize your employer match. After you’ve claimed all the free money your employer is willing to give, then it can be smart to look at a Roth as a secondary option. But with many employers offering matching contributions when you contribute as much as 6 percent or more of your salary, doing both 401(k) and a Roth might be more than you can afford.
You’re Scared of Washington
What the tax laws give, tax law changes can take away. For instance, the latest administration budget proposal would set maximums on the amount of tax-favored retirement savings that you can set aside, as well as other provisions that would impose required minimum distributions on Roth IRAs for the first time. Some analysts worry that more substantive changes could be next, including potentially adding a surtax to Roth IRA distributions to effectively remove their tax-free status.
The advantage of traditional IRAs is that you grab your deduction up front, making it impossible for lawmakers to take it away later. Although most believe that the chances of major Roth IRA changes are remote, those who are risk-averse should consider that possibility in choosing their retirement vehicle.
You can follow Motley Fool contributor Dan Caplinger on Twitter @DanCaplinger or on Google Plus.
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