Ask Money

To Roth or not to Roth

Chris Farrell Jan 21, 2011

Question: I recently got a new job where there is no employer sponsored retirement plan. I’m still young, only 26, but I don’t have a lot of excess money at the moment but I want to make sure I continue putting some away for retirement.

I was thinking either a ROTH IRA or a traditional IRA. I have researched the pros and cons and see that both have different opportunities.

Is there one that I should do over the other? AND is there any other investment vehicle that I should look for? Natalie, Kingston, NY

Answer: Congratulations on setting up your own retirement savings plan. I wish everyone would.

As a general rule, I think the single best retirement savings plan you can set up on your own is the Roth IRA.

Yes, your contributions into the Roth will be with aftertax dollars. You give up the upfront tax break tied to contributions into a traditional IRA. But since you’ve already paid tax on the money going in with the Roth you don’t have to pay taxes on the accumulated gains when you withdraw money during retirement.

So, if you fund a Roth IRA at age 26 and it compounds until you withdraw it in retirement, say at age 65, you don’t pay any tax on the gain. Nada. Nothing. With the traditional IRA, you’ll pay your ordinary income tax rate at that time on withdrawals.

But there are a couple of other factors that push me toward favoring the Roth. One big advantage is that in a pinch you can withdraw your Roth contributions without paying a penalty or taxes to Uncle Sam. (With the traditional IRA you’ll pay a 10% penalty and ordinary income tax rates on the withdrawal.) Just leave the investment returns alone since you would pay taxes and penalty on that portion of the withdrawal.

In other words, the Roth is a backstop to your emergency fund.

Odds are you will end up working for an employer that will offer you’re a tax sheltered 401(k) or 403(b). With that kind of retirement savings plan you’ll pay income taxes on the money you take out during retirement. The Roth allows you to diversify the tax treatment of retirement savings and that will give you extra financial flexibility in your old age.

Last, and this is way down the road for you, but unlike a traditional IRA, you don’t have to start taking money out of a Roth in the year you turn 70½. You’re never required to take distributions from your own Roth IRA. (Your beneficiaries will have to after your death.)

Where would I invest it? A very good and extremely short book for investing over the long-haul is The Elements of Investing by Burton Malkiel and Charles Ellis. The two finance legends modeled their book after the famous (among writers at least) The Elements of Style by William Strunk and E.B. White.

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