Roth IRAs are a popular retirement account option for a reason. This is because they are easy to open with an online broker and, historically, offer an average annual return of 7 to 10%. Contributing to a traditional IRA can generate a current tax deduction and, in addition, allows for tax-deferred growth. While long-term savings in a Roth IRA may result in better after-tax returns, a traditional IRA can be an excellent alternative if you qualify for a tax deduction.
Use this traditional IRA calculator to see how much you could save with a traditional IRA. A Roth IRA can increase in value over time by increasing interest. When investments generate interest or dividends, that amount is added to the account balance. Account holders can then earn interest on the additional interest and dividends, a process that can continue over and over again.
The money in the account can continue to grow even without the owner making regular contributions. For example, Congress could make changes to the tax code during the intervening years. If you're going to open the Roth later in your life, you need to make sure you can have it for five years before you start accepting distributions in order to take advantage of tax benefits. If you invest that immediate windfall from using a traditional account, as we have argued before, a Roth may offer the best tax option.
However, money has many uses besides investing it. The amount saved by making a maximum contribution to the account in pre-tax dollars could be used for any number of useful purposes, including vital ones, for buying a home, creating an emergency fund, taking vacations, etc. Nor are you required to withdraw from your Roth IRA while you live if you don't want to, making Roth IRAs quite valuable estate planning tools. Under certain conditions, Roth IRAs also allow tax-free earnings to be withdrawn, which are subject to taxation in a traditional IRA.
If you don't name a beneficiary, your spouse (if he is your primary beneficiary) can choose to inherit your Roth IRA or transfer it to a Roth IRA in your name. Every year you make a contribution to the Roth IRA, the custodian or trustee will send you Form 5498 with information about IRA contributions. You may be able to get around income limits by converting a traditional IRA to a Roth IRA, which is called a clandestine Roth IRA. Converting to a Roth IRA from a taxable retirement account, such as a 401 (k) plan or a traditional IRA, has no impact on the contribution limit; however, making a conversion increases the MAGI and may cause or increase the phasing out of the Roth IRA contribution amount.
The five-year Roth IRA rule states that you can't withdraw your earnings tax-free until at least five years after you've first contributed to a Roth IRA.