Over the last decade, the total number of households with Roth IRAs has increased by 47%. This rapid growth clearly shows the value of these plans. But why exactly are people so thrilled about Roth accounts?
The most prominent difference between Roth IRAs and traditional plans is that Roth contributions are made post tax. With traditional retirement accounts, savers contribute pretax dollars and pay normal tax rates upon withdrawal of the funds. With Roth plans however, individuals pay normal tax rates before contributing.
Because of the relatively flexible rules surrounding Roth accounts, they have a variety of uses. Though it is most common to use the funds for retirement, some people utilize the accounts to fund college or as emergency funds. This is possible because of IRS rules stating that any contributions that you have made to your account can be withdrawn with no tax liabilities at any time. [After age 59½, all withdrawals (including accrued interest) are tax free.]
Roth funds also allow for larger value contributions. The IRS only allows taxpayers to contribute $5,500 per year ($6,500 if over age 50) to their retirement account each year, no matter the type. However, since Roth contributions are post-tax, their total value can be significantly higher than that of a traditional fund. Furthermore, Roth accounts have no mandatory annual payouts after age 70½ .
All of the benefits offered by Roth accounts usually outweigh the loss of the upfront tax breaks offered by traditional plans. However, this may look different on a case by case basis.
The important decision for taxpayers is to determine whether they are better off to invest in a traditional IRA or 401(k) with pre-tax dollars or in a Roth with post-tax dollar. The answer to this question lies in your tax bracket. If you expect your tax rate on withdrawal to be higher, you will be better off with a Roth account. If your tax rate is likely to be lower, you should stick to a traditional IRA or 401(k).