What is Foolsaurus?

It's a glossary of investing terms edited and maintained by our analysts, writers and YOU, our Foolish community. Get Started Now!


Roth IRA vs. Traditional IRA for Young Adults

Original post by Mark Kennan of Demand Media

The best time to start saving for retirement is when you are young because the money has a long time to grow. The more you put away during your 20s and 30s, the less catching up you will have to do in your 40s and 50s. Knowing how Roth and traditional IRAs work helps you plan the most tax-advantageous way to save.

Contents

Estimating Future Tax Rates

Many young adults find themselves in entry-level or lower-level jobs with salaries to match, which means they fall in a lower income tax bracket. While nothing is certain, chances are they will fall in a higher income tax bracket at retirement. If this applies to you, consider a Roth IRA contribution rather than a traditional IRA contribution because it is better to pay the lower income tax rate when you make the contributions than the higher income tax rate when you make withdrawals.

Traditional IRA Deduction Eligibility

Depending on the company that you work for, you may have access to an employer retirement plan, such as a 401k plan or 403b plan. If so, your traditional IRA contribution may not be tax deductible, which eliminates a significant advantage of the traditional IRA. For example, as of the time of publication, if you are single you cannot deduct any of your traditional IRA contribution if your modified adjusted gross income exceeds $66,000. This amount adjusts annually and the IRS publishes it in Publication 590. Whether you actually contribute to the employer plans is irrelevant; it only matters that you could contribute.

Needing Extra Cash

As a young adult, you may need every last dollar that you can scrape up to pay you current expenses or accumulated debt. Even if you fall in a lower tax bracket, the tax savings can still be substantial for making a contribution to a traditional IRA. For example, if you fall in the 15 percent tax bracket and contribute $5,000 to a traditional IRA, the tax deduction would save you $750. However, if you are that strapped for money, you may need to reconsider whether you should be contributing to an IRA or paying down your debts.

Retirement Savings Credit

Depending on your adjusted gross income, you may be able to claim the Retirement Savings Credit for money you put in to your Roth IRA or your traditional IRA; both accounts qualify. The Retirement Savings Credit offers a tax credit equal to a portion of your contribution between 10 and 50 percent, and can save you up to $2,000 on your income taxes, depending on your filing status and adjusted gross income.


                   

References

About the Author

Mark Kennan is a freelance writer specializing in finance-related articles. He has worked as a sports editor for "Ring-Tum Phi" and published articles on a number of online outlets. Kennan holds a Bachelor of Arts in history and politics from Washington and Lee University.


Advertisement