Question

There is a choice between a Roth IRA and a Traditional IRA. Lately there is also expanding offering of Roth retirement plans through employers as well.  

What should drive someone's decision as to whether to choose a Roth option or a traditional option? Do you think people make good decisions on these lines? Is offering both alternatives a good idea or does it just make the choices too complex?

Answer 1

With traditional IRAs, the contributions to the IRA are tax-free, but the withdrawals later are taxable. They are in the nature of pension accounts because there are restrictions regarding the withdrawals and their timing.

With a Roth IRA, the contributions to the IRA are taxable, but the withdrawals later are tax-free. They are in the nature of investment accounts because there are fewer restrictions on withdrawals and their timing.

Thus, whether to choose a tradition or Roth IRA depends on the individual's objectives. If the individual is saving solely for retirement or long-term, and has no need for these funds in the medium-term, then a traditional IRA is better since the contributions grow tax-free. However, if the funds in IRA may be required at some point in the medium-term (such as for buying a house), then a Roth IRA may be a better option because the funds can withdrawn whenever required.

Many people do not make good decisions on these lines due to lack of information, awareness and guidance. However, there are many people that do make good, informed decisions.

Offering both alternatives is a good idea because the investor is given the flexibility to choose the plan that best suits them. It is not too complex, and with the right guidance/information, the investor is better off having the choice rather than without.