What if your employer doesn't offer a 401k or 403b plan? How else can you start investing for retirement? Some retirement plans do not require employer sponsorship.
These plans are called individual retirement accounts (IRA) and there are two options to consider. The plans are exactly the same except for how taxes are determined. If you choose a Roth IRA, you will pay taxes on your contributions to the account now. If you choose the traditional IRA, you will pay the taxes when you retire and withdraw the money.
How do you decide which one is better: Roth IRA or IRA? You will need to ask yourself if your income tax rate would be higher now or when you retire. Most people have higher incomes while working rather than at retirement, so an IRA is the better choice. The Roth IRA would be better if you think your income will be higher when you retire. The table below gives you a better idea of how the taxes work.
| When to Pay Taxes | Income at Retirement | Income While Working | Tax Rate | Tax You Pay | |
|---|---|---|---|---|---|
| Roth IRA | Now | $30,000 | $75,000 | 6% | $4,500 |
| IRA | When You Retire | $30,000 | $75,000 | 6% | $1,800 |
If you make $75,000 now and $30,000 in retirement with a 6% tax rate, what would you pay in tax for both accounts using the following formula?
income × tax rate = amount of tax payment
- Roth IRA: $75,000 × .06 = $4,500 tax paid now
- IRA: $30,000 × .06 = $1,800 tax paid at retirement
Which one would be better for tax purposes?
The IRA is better due to a higher income now and less to pay in taxes at retirement.
If you make $30,000 now and $75,000 in retirement with a 6% tax rate, what would you pay in tax on both?
- $30,000 × .06 = $1,800 tax on Roth IRA now
- $75,000 × .06 = $4,500 tax on IRA at retirement
Which IRA would be better?
The Roth IRA is better because you pay the tax now when your income is less.
You can open an IRA at an investment firm or bank. To open an account, you must have taxable income. The investing process is the same as other investments. You choose investments—usually mutual funds, stocks, and bonds—and the risks and rewards are also the same.
Question
Why is it a good idea to invest in an IRA or Roth IRA if your employer doesn't offer a retirement investment option?
Investing for retirement is important. The Roth IRA or IRA are good choices if your employer doesn't offer a plan. The difference is when taxes have to be paid. The Roth IRA collects taxes up front, while the IRA collects taxes when you retire.
