Roth or Traditional IRA. If you go to work for an employer that does not sponsor a retirement plan, which kind of personal retirement account would you establish? A traditional IRA or a Roth IRA? Give two reasons to support your response. How much money do you think could accumulate in the account before retirement?
The choice between traditional and Roth IRA really depends on the person and their likelihood of earning in the future. I am basing my evaluation on two assumptions. First, I assume that I am a younger worker, late twenties to early thirties. Secondly, I assume I am expecting or at least striving for career advancement and future pay raises. In this scenario, the best choice is a Roth IRA.
The main reason is for tax purposes. A Roth IRA is not eligible for tax deductions, but can be eligible for some tax credits like the 'savers credit'. On a Roth IRA the deductions taken in the future are tax free. This is the best option when retirement tax bracket is expected to be higher than during the contribution timeframe. Basically, if I expect to making more in the future and thus in a higher tax bracket I want the contributions taxed at my current, lower rate.
A secondary reason for the choice of a Roth IRA is the age limitations and distributions. With a Roth IRA there is no age limit when I must stop making contributions. This means if I work until I'm 70 or 80, I can continue to make contributions to the account which may be passed on to my beneficiaries. There is also no distribution age. A traditional IRA must be start pay-outs when the owner reaches 70.5 years of age. The Roth IRA has no such mandates.
The Roth IRA can very easily yield over $1 million dollars.
Starting Balance: $0
Annual Contribution: $5,000
Current Age: 29
Retirement Age: 70
Rate of Return: 7%
Marginal Tax Rate: 25%
Roth IRA Balance: $1,148,161