Retirement Hacks: Here’s when you should choose a Roth IRA over a traditional account

Traditional IRAs are a great option for people who expect to earn less in retirement. The money is invested with pre-tax dollars, which means contributions feel fuller when invested and are taxed at distribution. People who anticipate they’ll be in lower tax brackets in retirement would therefore want to withdraw from a traditional IRA when they’re in as low as a tax bracket as possible. 

See: When a traditional IRA makes sense over a Roth account

Conversely, Roth IRAs are an ideal solution for people who are in low tax brackets now and expect to face higher rates in the future. The money is contributed with after-tax dollars, but when distributed properly they are invested tax-free. This could be the right choice for people who are just starting out in their careers. 

Roth IRAs also make sense for investors who expect the government to raise tax rates by the time they enter retirement. The current tax rates are expected to end in 2026, though it is uncertain if any changes to tax laws would happen beforehand.

Some investors are closely watching what this administration and future administrations may do — so much so that people have already begun converting portions of their traditional IRAs to Roth accounts to avoid paying more in higher tax brackets in the future. (Legislators have proposed ending Roth conversions for people in higher income brackets, though it’d be another decade before that rule would begin if it were passed.) 

Unlike traditional accounts, Roth accounts do not have any tax deductibility features. But they do have a perk unlike their traditional counterparts – they do not have required minimum distribution rules, which is when account holders would otherwise need to begin taking withdrawals from their accounts if they hadn’t already started by age 72.

Also see: Why I won’t do a Roth IRA conversion – even if this is the last chance 

Roth IRAs do have rules regarding distributions. For example, an investor’s contributions are always available tax-free, but any conversions and earnings must meet certain guidelines before they’re eligible to be withdrawn tax- and penalty-free. 

Roth accounts must be opened for five years and an individual must be 59 ½ years old for most qualified distributions to occur, but there are exceptions, such as disability or death, or $10,000 toward a first home purchase or medical insurance premiums while unemployed. Nonqualified distributions face a 10% additional tax. Investors should take careful note of when and how much they contribute as each conversion or contribution has its own 5-year rule, the IRS said.  

Similarly to traditional IRAs, account holders have until Tax Day to contribute to their IRA on behalf of the prior year. For example, someone who hasn’ maxed out their IRA in 2021 (which was $6,000 for people under age 50 and $7,000 for those 50 and older) had until Tax Day in 2022 to contribute to last year’s limits, though they would have had to specify that’s how they wanted the money used to their investment firm. 

Tax Day for 2022 may be over now, but it’s one tip to keep in mind for next year if you’re bogged down with other financial obligations the rest of this year. 

MarketWatch hosted a “Mastering Your Money” virtual event, which included sessions on various important personal finance topics. During one session, reporters and editors tackled some of the most controversial personal finance decisions, including when to invest in a traditional IRA or Roth IRA, if leasing or buying a car makes most sense and why you may or may not want to go with a Health Savings Account. Watch a replay of the event here.