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As a young professional starting a new career, what would you recommend a Roth IRA or IRA?

Jan 05, 2012 by Santiago from San Diego, CA in  |  Flag
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7 votes

Julian and Don gave you some great advice. And for getting started at an early age, a Roth (either IRA or 401k) is a great first step.

But let's face it, you can't predict what your future earnings or tax rates will be. And unless you have a crystal ball, it's impossible to know what the best approach will be 40 years from now when you retire.

This can be hard to do, but try to imagine your life in retirement, and specifically replacing your paycheck with other sources of income. You need options for doing that in the most tax efficient way possible, which means you need three distinct buckets of money: 1) tax exempt, 2) tax deferred and 3) taxable.

With a Roth (tax exempt bucket) there's no upfront tax break, but in retirement you don't owe any tax on withdrawals. The same is not true of traditional IRAs (tax deferred bucket), because you got a pass from Uncle Sam on the contribution, you owe taxes when you take out your money. Individual accounts (taxable bucket) get no up front break, but offer capital gains rates which are preferable over earned income rates.

At your stage of life, the key is to just GET STARTED. Can you make the argument that the Roth probably is best for a young person long term? Yes, but if you told me you absolutely need the tax savings now, then open a traditional IRA. Either choice you make, you're headed in the right direction. And by the way, the kinds of investment you would ideally own in each tax bucket are not the same.

But that's for a different post!

1 Comment   |  Flag   |  Oct 10, 2012 from Berwyn, PA

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Flag |  Dec 16, 2019

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6 votes

I would suggest using your employer sponsored 401(K) and take advantage of any matching that is offered by your company. After that, if you have free cash flow and fall underneath the income threshold, I would suggest saving into a Roth. If you are a young professional with a high salary such as doctor, dentist or lawyer, you may not be able to contribute to a Roth IRA but should check to see if your company offers a Roth 401(k).

View all 4 Comments   |  Flag   |  Jan 07, 2012 from Boston, MA
Subramanian Krishnan Iyer

Since you are a professional, you will probably have a good income and if you save diligently over your career, your tax rate will be the same or higher in retirement compared to what it is now. Since a dollar invested in a Roth (principal and growth tax free) is worth more than a pre-tax dollar (principal and growth tax deferred), and they are both worth more than a post-tax investment dollar (principal tax free, growth tax deferred), if you have the choice between maxing out a Roth vs a regular (IRA or 401k), you should max out the Roth.

Flag |  Jul 20, 2012 near Jersey City, NJ
Subramanian Krishnan Iyer

The Roth is also a great option for inter-generational wealth transfer.. Say you give it to your grand kids (trust fund!), they are required to take RMD over their lifetime, and it tax-free growth and withdrawal for you and them - that is tax-free for a very long time horizon. Obviously this is not advice, just an idea to consider; you need a competent RIA, tax lawyer, accountant, trustee
etc. to implement this.

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Flag |  Jul 20, 2012 near Jersey City, NJ

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6 votes
Don Unger, MSFS Level 18

Imagine you are a farmer and it is time to plant your crop. Uncle Sam offers you a choice, you can pay the tax you owe on the current value of the seeds you are about to plant or you can wait six months and pay the tax on the value of the crop. Most people would see the wisdom in paying it on the lower value of the seeds today. That is the same option you have with a traditional IRA and a Roth IRA. Pay the taxes on the lower amoount of money going into the Roth today, or pay taxes on the much larger value in the Tradtional IRA later.

Visit a local independent financial planner and look at the numbers.

The information provided should not be interpreted as a recommendation, no aspects of your individual financial situation were considered. Always consult a financial professional before implementing any strategies derived from the information above

Comment   |  Flag   |  Oct 09, 2012 from Henrico, VA

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3 votes

While all of this is good advice, lets not lose the Forrest for the trees. What's most important is your savings rate and asset allocation. Next to those decisions the Roth/IRA decision is insignificant. A young professional saving 14% of income using an 80% equity portfolio will - 30, 40 years from now - run circles around one that defers 4% in a 40% equity portfolio- weather its pre-tax, post tax or anything in between. Get the deferral amount and allocation right, stay disciplined- and it will all work out just fine.

1 Comment   |  Flag   |  Oct 12, 2012 from Port Washington, NY
Erik Evans, CFP®

Right on!

Flag |  Oct 12, 2012 near Berwyn, PA

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1 vote

If you are in your 30's or early 40's, it's usually better to choose Roth over IRA. But before you choose anything make sure you are not giving up something of larger value, such as: 1) If your company plan provides a match, make sure you participate there, 2) Make sure you have a plan to build/replenish emergency savings, 3) Make sure your debts are decreasing.

There is nothing worse than working hard to build retirement funds, then to be forced to liquidate them for emergencies. I recommend a balance that makes you feel in control, and prepared for surprises.

3 Comments   |  Flag   |  Oct 21, 2012 from Reading, PA

I know that I am incredibly late to the conversation, but I am a firm believer in the pretax school of thought. How could any form of post tax investment (Roth or otherwise) compete with the growth potential in a traditional IRA/401k investment vehicle? Let's say that we have gross and net dollars to invest. If your effective tax rate is, say 15%, then your net dollars are only worth 85 cents in comparison to your gross dollars. That means that if you put your 401k investment in absolutely nothing and let it sit as cash, for your Roth investment to break even with the 401k account, it has to return a minimum of ~18%/yr to offset the 15 cents lost to tax. Again: this is before any form of returns that can be had in your 401k investment choices. This being the case, are you not effectively losing returns by not investing pretax? I understand the desire to avoid taxes in the future, but doesn't it make more sense to pay tax on more than to avoid tax on less? Let's not forget the benefit of reducing the dollars lost to tax each year as a result of your pretax investment. As you can see I am a staunch pretax supporter, but I would appreciate some counter viewpoints. My sister and I have gone back and forth about this for years (she sent me this article) and I would love to convince/be convinced one way or the other.

Flag |  Apr 24, 2013 near Houston, TX
Stephen J. Korving, CFP®

J, I see where you're coming from. The thing you need to take into account in your argument is future tax rates. If you think they'll be the same or lower in the future when you are taking funds out of the IRA/401k, and you think that you'll still be in the same tax bracket (15%), then I can see where you're coming from. However, if you think that tax rates are likely to be higher in the future and that you'll be in a higher tax bracket, then the cost of paying the taxes upfront (now) on a Roth contribution is outweighed by not having to pay taxes at a higher tax rate in the future when you withdrawal funds from the Roth. Also, Roth IRAs are not subject to Required Minimum Distributions (RMDs), so if you don't need any additional funds in retirement, you don't have to take any distributions from your Roth. Traditional IRAs are subject to RMDs, regardless of whether or not the owner wants or needs to take a withdrawal.

Flag |  Apr 26, 2013 near Suffolk, VA

Thank you for that point regarding the minimum distributions, Steven. That is a significant factor to take into consideration. Tax brackets may be higher in retirement, but one's cost of living should also be significantly lower. With no mortgage and healthcare as the largest expense item, there should only be so much income one should need to withdraw from retirement accounts in my estimation.

Flag |  Apr 26, 2013 near Houston, TX

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0 votes

The nice thing about the ROTH 401K is that it also allows you to manage how much taxable income you receive once you retire. We typically recommend having at least SOME of your contributions going into the ROTH side.

Comment   |  Flag   |  Dec 11, 2015 from Orlando, FL

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I agree with many in this conversation that the type of plan matters less. It is amount saved, allocation, and time that are the key factors, however, going under the assumption that all of those are well handled, I would highly encourage a Roth. Given that you are young and your compounding could be incredible over time, I personally would prefer to have all of that compounding on an after-tax basis.

Comment   |  Flag   |  Dec 15, 2015

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Have your cake and eat it to. Max out the full amount to your defined contribution plans/IRA/401(k) plans which is $53,000 in 2016. This amount will reduce your taxable income. Let that grow tax-deferred and then convert it over to a Roth IRA account when you're ready to retire. By then, hopefully you'll be an accredited investor and you can take advantage of the IRA valuation discounts to then convert your taxable IRA to a tax free Roth account as a discounted basis saving hundreds of thousands of dollars.

Comment   |  Flag   |  Feb 24, 2016

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Because you are both young and starting out in your career, a ROTH IRA is generally the way to go. The ROTH may provide you tax benefits if and when taxes increase in the future. Because you are young and just starting out in your career I am guessing you are in a lower tax benefit. Many young investors may be married with children and own a home, these can all be deductions for tax purposes, so another deduction may not provide a great deal of benefit. In retirement hopefully the home is paid off and the kids are gone, essentially you lose those tax deductions and tax free income from a ROTH can be very valuable.

Comment   |  Flag   |  May 12, 2016

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Steve Casull Level 13

If you are at a low income, then a ROTH. Are you planning on buying a home soon? You can take up to $10K for first time home buy. Do you see all the possible things you can take advantage of? I would need more information about YOU in order to give you good CLEAR information.

Comment   |  Flag   |  Feb 18, 2015 from South Jordan, UT

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