You Could Save for Retirement in a Traditional IRA. Here's Why a Roth Is Worlds Better

There's a reason savers are often encouraged to invest in an individual retirement account (IRA) for retirement instead of a regular brokerage account. With an IRA, your contributions result in a tax break. Your contributions are tax-free, and investment gains aren't taxed every year; those taxes are deferred until you're ready to take withdrawals in retirement.

With a brokerage account, there are no tax benefits whatsoever. You don't get a break on the money you put in, and you have to pay capital gains taxes every year if they apply (meaning, if you sold stocks at a profit).

When it comes to funding an IRA, you have two main choices: traditional and Roth. (There are other kinds of IRAs for the self-employed and small business owners, but those may not be applicable to you.)

Comparing traditional and Roth IRAs

The nice thing about a traditional IRA is that your contributions are tax-free up to the allowable limit set by the IRS each year. Currently, that limit is $7,000 if you're under age 50 or $8,000 if you're 50 or older.

So say you're 35 and manage to max out your traditional IRA with a $7,000 contribution. If you're in the 22% tax bracket based on your income, that contribution results in $1,540 worth of tax savings.

But while you won't get that same benefit with a Roth IRA, you shouldn't write off this type of account. In fact, Roth IRAs are actually worlds better than their traditional counterparts.

Why a Roth IRA wins out

It's true that a Roth IRA won't give you an immediate tax break on contributions like a traditional IRA. But you'll get two very important tax breaks over time: tax-free investment gains and tax-free withdrawals.

Tax-free gains

Let's talk about tax-free gains first. Imagine you contribute $200 a month to a Roth IRA over a 30-year period, all the while earning a 10% return each year in your portfolio. (That return is consistent with the stock market's average over the past 50 years.)

In that case, you're contributing a total of $72,000 to your Roth IRA. But you'll end up with about $395,000. When we subtract the $72,000 you put in, we're left with a gain of $323,000. And that gain is yours to enjoy without having to pay the IRS a dime in taxes.

Tax-free withdrawals

Roth IRAs also give you tax-free withdrawals in retirement. If you think taxes are stressful now, imagine losing a chunk of your income to them once you're no longer working and (in many cases) earning less. Not having to deal with taxes is a huge perk, but a traditional IRA won't give you that -- only a Roth will.

No required minimum distributions

Finally, Roth IRAs do not force savers to take required minimum distributions, or RMDs. RMDs force you to remove a portion of your balance each year in a tax-advantaged retirement plan. The amount of your withdrawal is calculated each year based on your account balance and life expectancy.

For some people, RMDs aren't a problem. If you have a $12,000 annual RMD but you were already planning to withdraw $1,000 per month from your retirement account to pay for living expenses, then it's no big deal. But if you don't need your money right away, RMDs are a hassle, and they force you to lose out on tax-advantaged growth in your retirement plan. With a Roth IRA, they don't apply, giving you much more flexibility.

Is a Roth IRA right for you?

One thing you should know is that if you're a higher earner, you may not be eligible for a Roth IRA. Singles earning above $161,000 and married couples earning more than $240,000 are barred from making contributions to one of these accounts. In that case, though, you can always contribute to a traditional IRA and convert it to a Roth.

But if you don't earn too much for a Roth IRA, then it pays to consider investing in one for the numerous benefits involved. You may find that your retirement becomes a lot less financially stressful if you have access to a Roth IRA throughout it.