Empower Traditional IRA vs Roth IRA

Which Retirement Account is Right for You?

Planning for retirement can feel overwhelming, but choosing the right Individual Retirement Account (IRA) is a crucial step towards securing your financial future. Empower, a leading financial services company, offers both Traditional and Roth IRAs.

Here’s the key features and benefits of each to help you make an informed decision.

Understanding the Basics: Traditional IRA vs. Roth IRA

Before we explore Empower’s specific offerings, it’s essential to grasp the basic differences between Traditional and Roth IRAs.

Traditional IRA: Tax-Deferred Growth and Immediate Tax Benefits

A Traditional IRA is a retirement savings account that offers tax-deferred growth on your investments. You won’t pay taxes on your earnings until you withdraw the money in retirement.

Contributions to a Traditional IRA may be tax-deductible, depending on your income and whether you’re covered by an employer-sponsored retirement plan.

Roth IRA: Tax-Free Growth and Withdrawals

A Roth IRA is funded with after-tax dollars. While you don’t get an immediate tax deduction for your contributions, your money grows tax-free, and qualified withdrawals in retirement are completely tax-free.

Empower Traditional IRA: Key Features and Benefits

Now, let’s take a closer look at the specific features and benefits of the Empower Traditional IRA:

1. Tax-Deductible Contributions

One of the most attractive features of a Traditional IRA is the potential for tax-deductible contributions. Depending on your income and whether you’re covered by an employer-sponsored retirement plan, you may be able to remove your contributions from your taxable income for the year.

This can provide an immediate tax benefit, potentially lowering your current tax bill. For example, if you’re in the 24% tax bracket and contribute $6,000 to a Traditional IRA, you could potentially reduce your taxable income by $6,000, saving $1,440 on your taxes for that year.

This immediate tax savings can be especially useful for those in higher tax brackets or those looking to reduce their current tax liability.

2. Tax-Deferred Growth

The money in your Empower Traditional IRA grows tax-deferred, meaning you won’t pay taxes on your investment gains, dividends, or interest until you withdraw the funds in retirement. This tax-deferred growth can potentially lead to larger account balances over time compared to taxable investment accounts, as all of your money stays invested and compounds without being reduced by annual tax payments.

Let’s look at an example to illustrate the power of tax-deferred growth:

Suppose you invest $6,000 annually in a Traditional IRA for 30 years, earning an average annual return of 7%. Assuming you’re in the 24% tax bracket, here’s how your account might grow compared to a taxable account:

Traditional IRA: $566,765
Taxable Account: $505,365

That’s a difference of over $61,000, simply because of the power of tax-deferred growth!

3. Flexible Investment Options

Empower offers a wide range of investment options for your Traditional IRA, including:

Individual stocks
Bonds
Mutual funds
Exchange-traded funds (ETFs)
Real estate investment trusts (REITs)
Certificates of deposit (CDs)

This flexibility allows you to create a diversified portfolio tailored to your risk tolerance and investment goals. You can also adjust your investments over time as your needs and market conditions change.

For example, you might start with a more aggressive portfolio in your early career, heavily weighted towards stocks and growth-oriented mutual funds. As you approach retirement, you could gradually shift to a more conservative mix with a higher proportion of bonds and dividend-paying stocks.

4. No Income Limits for Contributions

Unlike Roth IRAs, Traditional IRAs have no income limits for making contributions. This means that even high-income earners can contribute to a Traditional IRA, although the tax deductibility of those contributions may be limited based on income and other factors.

For 2023, you can contribute up to $6,500 to a Traditional IRA ($7,500 if you’re 50 or older), regardless of your income level. This can be particularly beneficial for high earners who may be phased out of Roth IRA contributions or who want to maximize their tax-advantaged savings options.

5. Potential for Lower Tax Rates in Retirement

If you expect to be in a lower tax bracket during retirement than you are now, a Traditional IRA can be particularly beneficial. By deferring taxes on your contributions and earnings until retirement, you may end up paying less in taxes overall if your tax rate is lower when you start taking distributions.

For instance, if you’re now in the 32% tax bracket but expect to be in the 22% bracket in retirement, you could save 10% in taxes on every dollar you contribute to a Traditional IRA and withdraw in retirement.

Empower Roth IRA: Key Features and Benefits

Now, let’s explore the unique features and benefits of the Empower Roth IRA:

1. Tax-Free Withdrawals in Retirement

The most significant advantage of a Roth IRA is that qualified withdrawals in retirement are completely tax-free. This means that once you reach age 59½ and have held the account for at least five years, you can withdraw both your contributions and earnings without paying any taxes.

This tax-free income in retirement can be a powerful tool for managing your overall tax liability and maximizing your retirement income. For instance, if you’ve accumulated $500,000 in your Roth IRA by retirement, you can withdraw that entire amount tax-free, potentially saving tens of thousands of dollars in taxes compared to withdrawing the same amount from a Traditional IRA.

Let’s look at a concrete example:

Suppose you’ve saved $500,000 in a Roth IRA by age 65. If you withdraw $20,000 per year for 25 years (assuming no additional growth), you’ll receive a total of $500,000 in tax-free income.

If you were in the 22% tax bracket, this would save you $110,000 in taxes compared to withdrawing from a Traditional IRA!

2. No Required Minimum Distributions (RMDs)

Unlike Traditional IRAs, Roth IRAs are not subject to Required Minimum Distributions (RMDs) during the owner’s lifetime. This means you can leave your money in the account to continue growing tax-free for as long as you like, providing greater flexibility in retirement planning and potentially allowing you to leave a larger tax-free inheritance to your beneficiaries.

This feature can be particularly valuable if you don’t need to withdraw from your Roth IRA immediately in retirement. You can let your investments continue to grow tax-free, potentially for decades, while using other income sources or retirement accounts to cover your living expenses.

3. Flexible Withdrawal Options

Roth IRAs offer more flexibility when it comes to withdrawals before retirement. You can withdraw your contributions (but not earnings) at any time without penalties or taxes.

This feature can provide a safety net in case of financial emergencies, although it’s generally advisable to avoid tapping into your retirement savings if possible.

For example, if you’ve contributed $30,000 to your Roth IRA over the years and your account has grown to $50,000, you could withdraw up to $30,000 without any taxes or penalties, even if you’re under 59½. This flexibility can be invaluable in case of unexpected expenses or financial hardships.

4. Tax Diversification

Contributing to a Roth IRA can help you achieve tax diversification in retirement. By having both tax-deferred accounts (like Traditional IRAs or 401(k)s) and tax-free accounts (like Roth IRAs), you can strategically manage your withdrawals in retirement to minimize your overall tax burden.

For instance, in years when your other income is lower, you might choose to withdraw more from your Traditional IRA or 401(k). In years when your income is higher, you could rely more heavily on tax-free Roth IRA withdrawals to avoid pushing yourself into a higher tax bracket.

5. Backdoor Roth IRA Contributions

For high-income earners who exceed the Roth IRA income limits, the “backdoor Roth IRA” strategy can be an effective way to still contribute to a Roth IRA. This involves making a non-deductible contribution to a Traditional IRA and then immediately converting it to a Roth IRA.

While this strategy has some complexities and potential tax implications, it can be a valuable tool for those who want to take advantage of Roth IRA benefits despite income restrictions. Here’s a step-by-step breakdown of how it works:

Make a non-deductible contribution to a Traditional IRA.
Convert the Traditional IRA to a Roth IRA.
Pay taxes on any earnings that occurred between the contribution and conversion (which should be minimal if done quickly).
Enjoy tax-free growth and withdrawals in retirement.

Be aware that the IRS’s “pro-rata” rule can complicate this strategy if you have other Traditional IRA assets, so it’s wise to talk to a tax professional before attempting a backdoor Roth contribution.

Comparing Empower Traditional IRA and Roth IRA: Key Considerations

When deciding between an Empower Traditional IRA and a Roth IRA, several factors should be taken into account:

1. Current vs. Future Tax Rates

One of the most critical considerations is your current tax rate compared to your expected tax rate in retirement. If you believe you’ll be in a higher tax bracket in retirement, a Roth IRA might be more useful, as you’ll pay taxes on contributions now at a lower rate and enjoy tax-free withdrawals later.

Conversely, if you expect to be in a lower tax bracket in retirement, a Traditional IRA’s upfront tax deduction and deferred taxes might be more useful.

Consider this example:

Current tax bracket: 32%
Expected retirement tax bracket: 24%

In this scenario, a Traditional IRA might be more beneficial because you’d save 32% on taxes now and only pay 24% when you withdraw in retirement.

However, it’s important to remember that predicting future tax rates can be challenging, and it’s often wise to have a mix of both Traditional and Roth accounts to hedge against uncertainty.

2. Income Limits

While Traditional IRAs have no income limits for contributions, Roth IRAs do have income restrictions. For 2023, the ability to contribute to a Roth IRA begins to phase out at $138,000 for single filers and $218,000 for married couples filing jointly.

If your income exceeds these limits, a Traditional IRA might be your only option (unless you use the backdoor Roth IRA strategy). Here’s a breakdown of the 2023 Roth IRA income limits:

Single Filers:

Full contribution: Modified AGI up to $138,000
Partial contribution: Modified AGI between $138,000 and $153,000
No contribution: Modified AGI of $153,000 or more

Married Filing Jointly:

Full contribution: Modified AGI up to $218,000
Partial contribution: Modified AGI between $218,000 and $228,000
No contribution: Modified AGI of $228,000 or more

3. Time Horizon

Consider how long you have until retirement. The longer your investment horizon, the more time your money has to grow tax-free in a Roth IRA, potentially making it a more attractive option.

For example, if you’re 25 years old and have 40 years until retirement, the tax-free growth potential of a Roth IRA could be substantial. A $6,000 annual contribution growing at 7% per year could potentially grow to over $1.2 million after 40 years, all of which could be withdrawn tax-free in retirement.

However, if you’re closer to retirement and in a high tax bracket, the immediate tax deduction of a Traditional IRA might be more beneficial. You could potentially save a significant amount on your current tax bill and still have time for your investments to grow tax-deferred before retirement.

4. Required Minimum Distributions (RMDs)

To avoid RMDs and have more control over your withdrawals in retirement, a Roth IRA offers this flexibility. Traditional IRAs need you to start taking RMDs at age 72 (or 73 for those who turn 72 after December 31, 2022), which can impact your tax situation and overall retirement strategy.

RMDs are calculated based on your account balance and life expectancy, and failing to take them can result in hefty penalties (50% of the amount you should have withdrawn). This lack of flexibility can be a significant drawback for those who don’t need the income and would prefer to let their investments continue growing.

5. Estate Planning

If leaving a tax-free inheritance to your heirs is a priority, a Roth IRA can be an excellent tool. While beneficiaries of both Traditional and Roth IRAs must take distributions, the Roth IRA distributions will be tax-free, potentially providing a significant advantage to your heirs.

For example, if you leave a $500,000 Roth IRA to your children, they can withdraw the entire amount tax-free over a 10-year period (under current rules). If you left them a $500,000 Traditional IRA, they’d have to pay income taxes on each withdrawal, potentially reducing the inheritance by tens or even hundreds of thousands of dollars, depending on their tax brackets.

Making the Right Choice: Strategies and Considerations

Choosing between an Empower Traditional IRA and a Roth IRA doesn’t have to be an all-or-nothing decision. Here are some strategies and considerations to help you make the best choice for your situation:

1. Diversify with Both

Many financial experts recommend having both Traditional and Roth IRAs to provide tax diversification in retirement. This strategy allows you to manage your tax liability by choosing which account to withdraw from based on your tax situation each year.

For example, you might contribute to a Traditional IRA during your peak earning years to maximize your tax deductions, and then switch to Roth contributions as you approach retirement and your income (and tax bracket) decreases.

2. Consider a Roth Conversion

If you already have a Traditional IRA, you might consider converting some or all of it to a Roth IRA. This can be particularly useful if you’re in a lower tax bracket now than you expect to be in retirement.

Keep in mind that you’ll need to pay taxes on the converted amount in the year of the conversion. It’s often best to spread conversions over several years to avoid pushing yourself into a higher tax bracket.

For instance, if you have a $100,000 Traditional IRA and are in the 22% tax bracket, you might convert $20,000 per year over five years. This would result in an additional $4,400 in taxes each year, but could potentially save you much more in taxes during retirement.

3. Evaluate Your Overall Retirement Strategy

Your choice between a Traditional and Roth IRA should align with your broader retirement strategy. Consider factors such as:

Your other retirement accounts (e.g., 401(k), pension)
Expected Social Security benefits
Overall retirement income needs
Desired retirement lifestyle
Potential healthcare costs in retirement

For example, if you have a large 401(k) balance that will be subject to RMDs, you might prefer a Roth IRA to provide more flexibility and tax diversification in retirement.

4. Stay Informed About Tax Law Changes

Tax laws can change, potentially affecting the benefits of Traditional and Roth IRAs. Stay informed about any legislative changes that might impact your retirement savings strategy and be prepared to adjust your approach if necessary.

For instance, the SECURE Act of 2019 changed the RMD age from 70½ to 72, and the SECURE 2.0 Act of 2022 further increased it to 73 for those turning 72 after December 31, 2022. These changes give Traditional IRA owners more time for tax-deferred growth before RMDs kick in.

5. Consider Your Current and Future Cash Flow Needs

Think about how contributing to each type of IRA might affect your current budget and future retirement income. A Traditional IRA’s tax deduction might free up more cash flow now, which could be useful if you’re struggling to save or have high-interest debt to pay off.

On the other hand, a Roth IRA’s tax-free withdrawals in retirement might provide more spending flexibility and peace of mind in your later years.

6. Factor in State Taxes

Don’t forget to consider state taxes in your decision. Some states offer additional tax benefits for IRA contributions or have different tax treatment for IRA withdrawals in retirement.

For example, if you live in a high-tax state now but plan to retire in a state with no income tax, a Traditional IRA might be more beneficial. Conversely, if you expect to move to a higher-tax state in retirement, a Roth IRA could provide valuable tax savings.

7. Use Online Calculators and Seek Professional Advice

Empower and many other financial institutions offer online calculators to help you compare the potential outcomes of Traditional vs. Roth IRA contributions. These can be valuable tools for visualizing the long-term impact of your choices.

However, given the complexity of retirement planning and the significant impact it can have on your financial future, it’s often wise to talk to a financial advisor or tax professional. They can help you analyze your specific situation and make a recommendation tailored to your unique circumstances and goals.

Key Takeaways

Both the Empower Traditional IRA and Roth IRA offer valuable benefits for retirement savers. The Traditional IRA provides immediate tax benefits and tax-deferred growth, while the Roth IRA offers tax-free withdrawals in retirement and greater flexibility.

Your choice between the two should be based on your current financial situation, future expectations, and overall retirement goals. Remember, it’s not necessarily an either/or decision – many savers benefit from having both types of accounts to maximize their tax advantages and retirement planning flexibility.

By carefully considering the features and benefits of each account type, you can make an informed decision that will help you build a secure and comfortable retirement. Whether you choose a Traditional IRA, a Roth IRA, or a combination of both, the most important step is to start saving and investing for your future today.