When Should I NOT Open an IRA?

“In the world of financial planning, the Roth IRA sometimes looks like the cool younger brother of the more vanilla traditional IRA. Indeed, the Roth version, first introduced in 1998, offers a number of features that look pretty attractive: a lack of required minimum distributions (RMDs), the flexibility to withdraw money prior to retirement and the ability to make contributions past the age of 70½.”

Often choosing between a Roth or a traditional IRA, comes down to how much you’re making now and how much you expect to bring in once you stop working.

Investopedia’s recent article, “When Not to Open a Roth IRA,” explains that both types offer distinct tax advantages for those saving money for retirement. However, they work somewhat differently.

With a traditional IRA, you invest pre-tax dollars and pay income taxes, when you withdraw the money in retirement. You pay tax on both the original investments and what they earned. However, a Roth is the opposite: you invest money that’s already been taxed at the ordinary rate and withdraw it and its earnings tax-free at a later date.

In deciding one over the other, the key question is whether your income tax rate will be higher or lower when you start withdrawing funds. The other difference between the accounts is that RMDs are mandated by traditional IRAs. These are cash withdrawals from the account (on which you pay taxes) that must begin the year following the year in which its owner turns 70½. Roths have no RMDs.

For younger workers who have yet to realize their earning potential, Roth accounts have a definite edge. This is because when you first enter the workforce, it’s quite possible that your effective tax rate will be in the low single digits. Your salary will probably go up over the years. That means you’ll have greater income, and quite possibly be in a higher tax bracket in retirement. There is, therefore, an incentive to front-load your tax burden.

However, the opposite might be true, if you’re in your peak earning years. If you’re in one of the higher tax brackets now, it may have nowhere to go but down in retirement. If that’s the case, you’re probably better off postponing the taxes, by contributing to a traditional retirement account.

However, for the most affluent investors, the decision may be a moot point, because of IRS income restrictions for Roth accounts.

There are many unique benefits associated with a Roth IRA, but there’s no one-size-fits-all approach to retirement planning.

Reference: Investopedia (October 5, 2018) “When Not to Open a Roth IRA”