It can be difficult to plan for retirement, especially if you don’t have company-sponsored pensions or 401(k). You need to be able to save money and have the discipline to do so. There’s also the confusion of choosing which IRA vehicle you should use, a Roth plan or a regular IRA.
Stuart Ritter, vice-president of T. Rowe Price Investment Services, says that many people have difficulty deciding between a Roth IRA and a traditional IRA. This decision is often based upon a worker’s age and how they expect their tax rate will change when they retire. The latter can be difficult to predict but it is possible to answer the simple question: Do your goals remain the same? Plan for a similar tax.
Ritter stated that it is up to you which one will provide more income for retirement. The Roth IRA provides more income for retirement and allows you to make flexible investments.
The main difference between the two plans is that Roth IRA contributions are not tax deductible and withdrawals are exempt from tax. Traditional IRAs offer an initial tax break but withdrawals are subject to ordinary income tax.
T. Rowe Price’s study found that Roth IRAs would provide more income for workers in retirement. Consider a 30-year old worker who expects the same tax rate for retirement. A Roth will give her a 17 percent increase in disposable income than a traditional IRA.
Who wouldn’t benefit from a Roth IRA, then? The study showed that workers nearing retirement are most likely to have their tax rates reduced when they retire.
Ritter said that younger workers are starting to understand the Roth IRA’s benefits. The reason younger workers may find these plans appealing is because they may start saving while being in a lower tax bracket. This means that some of their retirement assets will be taxed at a lower percentage than when they are older and earn more.
The number of Roth IRAs has increased dramatically since 1997, when they were established as part of the Taxpayer Relief Act. According to the Investment Company Institute, Roth IRAs were held by more than 19 million Americans last year, compared to 36 million traditional IRAs.
One troubling statistic is that only 15% of U.S. households made contributions to any type IRA in 2012. This was according to an ICI study. IRAs have grown largely because of investment returns and rollovers from employers-sponsored retirement plans.
This is in line with a CBS News poll that found that more than 80% of Americans earning less than $50,000 per year say it’s difficult to save money for retirement and pay their bills. It’s imperative that employees in the private sector have access to retirement plans. Only half of workers have such access.
This may be why the average retirement account balance in the U.S. for all households of working age is only $3,000.
Ritter stated that Americans should set aside 15% of their income to prepare for retirement. This could be through an employer-sponsored plan or an IRA. Ritter said that workers with a 401k can invest in an IRA as long as they meet income limits.
He suggested that workers set up automatic monthly contributions into an IRA to make saving for retirement easy. Ritter said, “That puts it on autopilot.” “If you say, “I’ll see my tax refund or at year end,” that makes it more difficult than necessary.
