Roth IRAs and traditional IRAs offer important tax advantages that can save you a lot of money, and you know that when it comes to your retirement, every extra dollar counts. To begin with, we must first establish the differences between the two retirement systems.
The Roth IRA is nourished by contributions that the individual makes after taxes (you already paid taxes on it), but the earnings grow tax-free. You should also know that qualified withdrawals in retirement are tax-free. There are no mandatory minimum contribution (RMD) requirements during life, so you can contribute to your savings as much as you want or can.
On the other hand, traditional IRAs are plans whose contributions can be tax-deductible, which reduces the amount of taxable income in the tax year. The difference with the previous method is that the earnings grow with deferred taxes and, if you make withdrawals, they will be considered as income, so they will be taxed. In addition, you must start taking RMD from the age of 72.
An important detail is that, in the event of the beneficiary’s death, his heirs must withdraw the remaining funds within the next 10 years after the death.
Here’s a comparative chart between a Roth IRA and a Traditional IRA retirement plan:
| Feature | Roth IRA | Traditional IRA |
| Taxes on contributions | After-tax |
Before or after-tax (deductible)
|
| Taxes on earnings | Tax-free | Tax-deferred |
| Taxes on withdrawals | Tax-free (qualified) |
Taxed as income
|
| Distribution requirements | No RMD |
RMDs starting at age 72
|
| Heirs | Must withdraw funds within 10 years |
Must withdraw funds within 10 years
|
Should I Turn My 401(k) Into a Roth IRA?
If it’s not on the horizon that you’re going to need to access your retirement money anytime soon, it could be beneficial to convert your 401(k) into a Roth IRA. Making this transformation involves moving your money from a tax-deferred plan to a pre-tax one.
By doing this, income taxes will be paid on the money invested in the year the conversion is made, but in return you get something very positive: the benefit that the future earnings of the money in your Roth IRA grow tax-free and that withdrawals in retirement are also tax-free.
Advantages of converting to a Roth IRA
It offers several key financial benefits. First, you enjoy tax-free growth, which means that the earnings generated by your Roth IRA are not subject to taxes, allowing your money to grow faster and more effectively in the long run.
In addition, when withdrawing funds from your Roth IRA during retirement, as long as you meet certain requirements, those withdrawals are income tax-free, giving you a tax-free source of income. This flexibility also extends to the absence of mandatory minimum distribution (RMD) requirements in Roth IRAs, unlike traditional 401(k)s, allowing you to keep your money invested as long as you want.
Finally, another significant benefit is the ability to leave your Roth IRA to your heirs without them having to pay income taxes, providing an efficient and tax-free way to transfer wealth to future generations.
Disadvantages of converting to a Roth IRA
Converting to a Roth IRA also comes with certain disadvantages to consider carefully. First of all, you should be prepared to face immediate income taxes on the converted money in the year the conversion is made, which could have an impact on your effective tax rate for that period.
Furthermore, it’s important to be aware of potential costs associated with the conversion, such as administrative fees or penalties that could arise when moving funds from a 401(k) to a Roth IRA.
Another disadvantage to keep in mind is that, in situations where you need to access your retirement funds ahead of schedule, you could face taxes and penalties for early withdrawals from your Roth IRA, which could decrease your disposable income in retirement.
The final decision is yours alone and you should consult with a retirement and investment expert to find the option that best suits your needs and resources.