Income taxes are painful and you want to avoid them or pay as little as humanly possible. I get it.
That’s how I was feeling when a tax preparer told me that I owed thousands BUT that I could lower the amount if I put $5,500 (current max allowable per year) in a traditional IRA (Individual Retirement Account).
Save on taxes and for save for retirement all in one move?! A double win!
Well, sorta. I came to realize that it wasn’t such a brilliant plan after all. Let me explain.
In the IRA world there are two basic types: traditional or Roth. The key difference between them is when you pay taxes.
In a traditional IRA you pay taxes later – you pay it when you withdraw the money during retirement. The upside is that you get the tax deduction now (hence why the tax preparer recommended this one to me).
That sounds all well and good UNLESS you think that you’ll be in a higher tax bracket during those “retirement” years. I’m predicting that in my fifties, sixties, and beyond I’ll be making more money than I do right now. For this reason, the right choice for me is a Roth IRA.
In a Roth IRA you don’t get a tax deduction now but you also don’t pay taxes on the money when you withdraw it later. You essentially pay the taxes on it now and it grows tax-free.
Since I imagine myself earning more as I get older and therefore in a higher tax bracket down the line, I’ll get more value out of giving up the deduction for now and withdrawing all the money later without paying taxes on it.
So while I know every instinct in your body is urging you to pay less in taxes now, take a breath and look into the future – will you earn more or less money in your “retirement” years than you do right now?
If you predict you’ll make more, go with Roth.
If you think you’ll make less, go with traditional.
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