Beauty of Roth IRAs, 401(k)s

When saving for retirement, you can choose between traditional and Roth IRAs; your employer may even offer both traditional and Roth 401(k)s. You might consider the Roth options for their potentially massive tax breaks.

Like other IRAs and 401(k)s, Roth varieties let you accumulate money for retirement and enjoy some tax advantages at the same time. While traditional IRAs and 401(k)s are tax-deferred, permitting you to contribute pre-tax dollars, Roth accounts are designed to be tax-exempt and accept only already-taxed dollars.

Imagine that beginning at age 40, you invest $5,000 of your posttax income into a Roth IRA each year, and earn an 8 percent annual return for 25 years until you retire at 65. Your account would then contain almost $400,000, which you could withdraw in retirement tax-free.

If those investments had been made in a regular IRA, you’d owe taxes on any withdrawals, paying around $48,000 or so, assuming a 12 percent tax bracket during retirement, or $96,000 if you’re in a 24 percent bracket. So far, this makes a great case for the Roth.

But remember that if the $5,000 had gone directly into a traditional IRA, you would have reaped about $1,200 in tax savings each year at a 24 percent tax rate (more, with a higher tax rate). If that sum were also invested, the total difference between the Roth and the regular IRA would become slimmer. Still, the Roth is a compelling proposition for many investors.

You may be able to roll over, or convert, your traditional IRA into a Roth by paying taxes on it; you can generally roll over a 401(k) account into a traditional or Roth IRA when you change jobs, too. The 2018 contribution limit for both Roth and traditional IRAs is $5,500 ($6,500 for those 50 and older). For 401(k)s, it’s $18,500 ($24,500 if 50 or older).

Learn more about Roth account benefits and limitations at irs.gov or fool. com/retirement, or from a tax professional. For clear and concise retirement advice, along with stock and fund recommendations, try our “Rule Your Retirement” service at fool.com/services.