The Award for Best Beginner Retirement Account Goes To…

With so many choices for tax-advantaged retirement accounts, identifying the cream of the crop can be even more challenging than choosing the best picture at the Oscars from an array of awe-inspiring movies.

But when considering all the advantages each account can provide to retirees, there’s one clear winner that stands out from the crowd and definitely deserves your investment dollars.

Drumroll please, that account is…

Image source: Getty Images.

The Roth IRA

Before I explain why the Roth IRA takes the coveted title of best beginner retirement account, let’s set the stage with a little background.

The Roth IRA is a retirement savings account you invest in with after tax dollars. Your tax savings comes later, when you’re allowed to make tax-free withdrawals as a retiree. This sets it apart from competitor accounts such as the 401(k) and traditional IRA, both of which you contribute to with pre-tax funds but which come with taxable withdrawals.

You can contribute up to $6,000 to a Roth IRA in 2021, or up to $7,000 if you are 50 or over and eligible for catch-up contributions. This is an aggregate or combined limit with a traditional IRA. While it’s lower than the limit for a 401(k), it’s still a hefty amount of money that can help set you up for a secure retirement.

Why the Roth IRA is the clear winner

The Roth IRA beat out the competitors in a tough match for the title of best beginner retirement account for a few key reasons. Here are some of the reasons it can be a better place for retirement savings than either a 401(k) or an IRA.

You can withdraw contributions tax-free any time. With a 401(k) or traditional IRA, you typically can’t withdraw either contributions or investment gains until you reach age 59 1/2 without facing a 10% penalty. But since Roth IRA contributions are made with after-tax dollars, you can take them out early without penalty (you shouldn’t do this because it could adversely affect your retirement nest egg, but having the option provides more financial flexibility if you need it).
You aren’t subject to Required Minimum Distribution rules. If you have a 401(k) or traditional IRA, you must begin taking money out after reaching age 72. If you don’t, you’ll face a penalty equaling 50% of the amount you should’ve withdrawn. But there’s no RMD rules for a Roth IRA, so you can take out money on your own schedule.
Your distributions from a Roth IRA won’t affect your Social Security benefits. Social Security benefits become partly taxable once income hits a certain limit. Distributions from a 401(k) or traditional IRA count in determining if your benefits are taxed — but distributions from a Roth don’t. You can take as much money out of a Roth as you want and not worry about it affecting your Social Security checks.
You won’t have to worry about taxes on distributions as a retiree. Money withdrawn from a traditional IRA or a 401(k) will be taxed. There’s a good chance your tax rate will be higher as a retiree due to rising government debt and the fact that tax rates are currently near historic lows.

And while a 401(k) puts up a good fight in the quest to be declared the best retirement account because of the convenience that comes from investing with an employer-provided account, the 401(k) is also inferior to a Roth (or traditional) IRA in a few other ways:

Anyone can invest in an IRA (as long as their income isn’t too high). By contrast, workplace 401(k) accounts must be offered by employers (or opened by the self-employed). Not everyone has access to a 401(k) at work.
You’ll have a broader choice of investment options. 401(k)s come with limited investment choices. With a Roth IRA, you can invest in virtually any asset you want that’s offered by the financial institution where you open your account.

Now there is one caveat to consider, though, and that’s the 401(k) match. If your employer matches 401(k) contributions, you’ll want to contribute enough to your 401(k) to get this free money before you invest in a Roth IRA. After all, while a Roth IRA has a whole lot of perks that enabled it to earn the coveted best account award, those perks don’t outweigh the benefits of free investment dollars.

Of course, once you’ve maxed out your employer match (or if you don’t get an employer match), the Roth IRA may be the clear choice.

The good news is, you don’t have to pick and chose. Just as you can see all the Best Picture nominees and not just the winning movie, you can invest money in all these different tax-advantaged accounts and cover all your bases.

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