“It Depends”

If you scroll through social media much, you have no doubt seen a lot of hype around opening a Roth Individual Retirement Account (IRA) as a path toward becoming a millionaire. I have two reactions each time I read this:

1 – I love the Roth IRA option.

but

2 – It isn’t always the best option for your situation.

Generally, you do better financially using a Roth IRA, but it isn’t required to become a millionaire. In fact, becoming a millionaire has nothing to do with IRA vs. Roth IRA, since plenty of people reach $1 million  with both.

What is an IRA?

An Individual Retirement Account (IRA), is a tax-advantaged account for saving or investing your money, and anyone with earned income can open one. A Roth IRA is also a tax advantaged account, to which you contribute earned income. The question of which to use is predominantly related to when you want to handle tax. With a traditional IRA, you pay tax on the money as you withdraw it in retirement. With a Roth IRA, you pay tax on the money before you contribute it. Since most of us are in a higher tax bracket, due to earning more money, at 60 compared to 20, there’s a lot of sense in using the Roth option, as the amount of tax you are paying is likely much lower.

It Depends. . .

However, the main reason when I talk with people about their top financial focus areas for the year, they elect to use a traditional IRA, rather than the Roth, is because they have other priorities, based on their particular life situation and goals.

Ex 1: If you are paying down high-interest debt (and yes, debt reduction is part of wealth building), you may be better off using a traditional IRA. This gives you money today to get rid of debt: student loans, credit card debt, etc.

Ex 2: You are starting a business or trying to avoid heavy debt. Again, you need more money now, so use the IRA.

Ex 3. You have kids/are pregnant, particularly in a high cost of living area. Unpaid parental leave; the high cost of child care; or establishing a solid cash reserve for emergencies means you probably will prioritize keeping more money now, even if that means paying more in taxes later in life.

Focus on Your Priorities

Your vision for your life may be to be a millionaire at a certain age, but your priorities may mean approaching it a little differently, based on your goals and other constraints. The best approach to money decisions is to grasp your top priorities each year, and focus on those alone.

For one person I worked with, her top priorities were:

1. Pay of $25,000 (50%) of her credit card debt, which was at 18% interest.
2. Pay for counseling to manage behaviors and anxiety associated with the debt.
3. Invest enough to gain her employer match in her workplace 401K.

Integrated personal, professional, and financial decision-making is the best approach to establishing your focus each year. It may be that opening a Roth IRA is the best route for you. Or it may be you need a different path toward your goals, based upon your current situation, values, and goals.

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Photo by Caroline Hall