Tax-free withdrawals on retirement savings are what lead many people to pick a Roth IRA account over a savings account. However, the proper management of traditional savings accounts has its benefits too – primarily, the ease with which someone can use their funds in case of an emergency prior to retirement.
Picking the right type of account can make a world of difference when a person decides to retire. Since this is such an important decision, it’s essential to explore both options in depth. That’s precisely what this article aims to do.
What Will I Learn?
- Understanding Individual Retirement Accounts (IRAs)
- Exploring Savings Accounts
- Roth IRA vs Savings Account: A Comparison
- Identifying Similarities and Differences
- High-Yield Savings Account vs. Roth IRA
- Making a Choice: Roth IRA or Savings Accounts?
- Frequently Asked Questions
Understanding Individual Retirement Accounts (IRAs)
The main purpose of delving into individual retirement accounts, such as a Roth IRA account, is to assist individuals in preserving their assets. Typically, these accounts impose significant restrictions on withdrawals, with some only permitting beneficiaries to make withdrawals after five years or upon reaching a specific age. Consequently, a Roth account may not be suitable for use as an emergency fund; individuals might need to open a separate account for that purpose. This underscores the importance of understanding the unique features and limitations of different individual retirement accounts and aligning them with one’s financial goals.
Defining a Roth IRA
A Roth individual retirement account is meant to allow people to contribute after-tax dollars to a fund that they typically won’t withdraw money from until they retire. There are ways to withdraw money from these accounts before retirement, but those withdrawals usually come with some form of penalty. To be able to retrieve funds without penalties, beneficiaries need to have had the account for five years and be over 59 and a half years old in most cases.
Benefits of a Roth IRA
The aforementioned tax-free withdrawals are one of the biggest advantages of using Roth IRA. At the same time, however, the money in the Roth IRA account grows without being subject to taxes. Although there are certain restrictions to this account, people can open it at any age. Money in the account can also be passed down to heirs without the amount being subject to taxes.
Limitations of a Roth IRA
There are annual contribution limits to consider. These change year over year and are different depending on the age of the account holder. In the 2023 tax year, the limit was $6,500 for people under age 50, with $7,500 being the limit for those 50 or older. Tax year 2024 will see the limit increase to $7,000 for those under the age of 50 and $8,000 for folks over that age.
Tax Implications of Roth IRAs
Mainly, these accounts are meant to be funded with after-tax dollars. There are situations where people will pay taxes on the money as it comes into the account. This is done so that all of the withdrawals can be tax-free.
It’s very important to check with a financial advisor to ensure that the account is being funded properly; this will allow the holder’s assets to grow without needing to pay anything on the back end.
Exploring Savings Accounts
There are different types of savings accounts; in general, however, this is just an account that anyone can open at their local bank or credit union. The money that is stored in the account could earn a certain amount of interest. People who want to use the account to save for their retirement will typically limit their withdrawals over the years.
Defining a Savings Account
Savings accounts are the typical accounts that a person can use to keep some money stored away in the bank. As mentioned, different banks and credit unions can have variations of these accounts. These can be interesting options to explore when the account is meant to put money away, particularly for retirement.
There are essentially certain “locks” that can be applied to withdrawals to ensure people don’t empty the account ahead of time. Some credit unions will also offer the possibility of earning higher interest rates for people who want to keep their money stored for the long haul.
Advantages of a Savings Account
The money in a savings account is secure, particularly if a trustworthy institution backs the account. There’s also the possibility of earning interest. If there’s a decent amount of money in the account and enough time passes, the account holder can expect higher returns. Withdrawing money from these accounts is much less complicated than it is from Roth IRA accounts.
Disadvantages of a Savings Account
In many cases, interest rates could vary over time; most banks work under a no fixed rates policy. That means that inflation could make the interest earned basically meaningless. Certain banks and credit unions are also known to reserve the best interest rates for only premium accounts that hold large sums of money. Most of all, these account options will charge their holders yearly or monthly fees.
Interest Rates in Savings Accounts
People who are seriously considering savings accounts as their way to store money for retirement need to look at the interest rates the banks offer very carefully. As previously stated, many accounts will feature variable interest rates. In those situations, even though the account holder does earn interest, the amount may just be enough to keep up with inflation. Generally speaking, savings accounts have lower interest rates than money market accounts and other types of investment accounts. However, with a money market account or other type of investment account, you could lose money.
Roth IRA vs Savings Account: A Comparison
At this point, it’s clear to everyone that each account type will have certain benefits that the other does not feature. Looking at some of these features side by side may be the best way to decipher which option will work best for each person.
This is one of the main differences that exists in the Roth IRA vs savings accounts dilemma. As previously stated, there are specific limits on Roth IRA contributions. This applies to both the amount of money that someone can deposit into their account and the withdrawals that they can subsequently make.
Roth IRA Contribution Limits
Why does a Roth individual retirement account have limits in the first place? These limits were set in place to prevent people who earn more money from obtaining higher returns. The idea was to make these retirement funds “fair.”
Savings Account Contribution Flexibility
Saving accounts provide much more flexibility when it comes to the amount of money that people can transfer to their accounts. Since there are no limitations on savings accounts, people who want to allocate more than \$ 7,000 a year to their retirement savings will have to use this type of account. People in a higher tax bracket may even benefit from having both IRAs and savings accounts.
By understanding Roth IRA withdrawals, one must take into consideration that Roth IRA accounts are also going to be more restrictive. That can actually turn out to be a good thing for some people. Certain workers will actively seek out Roth IRAs because withdrawing the money is more complex.
Traditional savings accounts, on the other hand, are more flexible. However, there could be certain regulations in place with certain savings accounts. These regulations are especially prevalent in accounts that offer higher interest rates.
Roth IRA Withdrawal Rules
Usually, people can only withdraw funds from their Roth IRA accounts when they’ve turned 59 and a half. Plus, the account needs to be at least five years old. When that’s not the case, there could be a 10% penalty added to the total withdrawal sum. That money will probably also be taxed.
There are exceptions to these rules. Sometimes, there will be federal decrees that allow account holders to withdraw their funds without penalties. These usually come in the wake of difficult financial situations because of things like the COVID-19 pandemic.
Savings Account Withdrawal Flexibility
The limits to the amount of money and times that a person can withdraw funds in a savings account vary. As mentioned, there are different types of accounts, particularly those held by the National Credit Union Administration, that run under specific guidelines. With a traditional savings account, a person can withdraw funds up to six times a month without penalties or fees.
Asset Protection in Both Account Types
IRA accounts are protected from bankruptcy up to $1,512,350. That’s an assurance from the Federal Deposit Insurance Corporation. The amount that’s protected increases over time to cover inflation.
Savings accounts may not be directly protected from creditors. In this situation, a person could look to open an asset protection trust. That could be one option to fully protect the funds in external retirement savings accounts.
Evaluating Growth Potential
This is where these two types of accounts tend to deviate the most. Savings accounts are ironically not going to be as flexible in their growth. Whereas in a Roth IRA, the account holder has more control over where their money is going. This can increase their chances of growing their account. To learn more about Roth IRA, read our detailed guide to uncover Roth IRA’s growth potential.
Roth IRA Growth Potential
One of the main benefits of Roth IRAs is the possibility of investing in different funds and even stocks. This can not only mean that the account beneficiary will benefit from the compound interest and potential dividends, but that a fluctuating interest rate does not bind them. It may be a riskier proposition, but the growth potential is certainly higher.
Savings Account Growth Potential
With savings accounts, the person essentially can only make the decision of which financial institution they want running their account. There’s a credit union or two offering around 7% interest rate year over year on their high-yield savings accounts. That’s pretty much the best rate currently available.
Identifying Similarities and Differences
It’s very important to know what to expect from either side to be able to make the right decision on which account to choose. There are certain similarities between both savings accounts and Roth IRAs that can confuse people.
Common Features of Roth IRA and Savings Account
Either option can serve as a retirement account. Although a savings account may feature a more flexible withdrawal process, the main goal of the account is for people to keep their money “in the bank” for as long as possible. The more money that goes into the account and the more time that goes by, the better the return. That’s the same for either option.
Contrasting Roth IRA and Savings Account
The main contrast between traditional savings accounts and Roth IRAs is the fact that the holder doesn’t have a lot of control, even in a high-yield savings account. It’s the bank or credit union that will determine the interest rate that account holders can potentially earn. In Roth IRA accounts, there’s a possibility to pick where the money can be invested.
High-Yield Savings Account vs. Roth IRA
Savings accounts have different purposes; there are people who could open these accounts for their kids, for example, and set customized restrictions on spending and withdrawals. High-yield savings accounts are meant to be the best option for people who are looking for high-interest rates and, therefore, better long-term returns. How does this option stack up to a Roth IRA account?
High-Yield Savings Account: Advantages and Disadvantages
The biggest advantage that this type of account brings to the table is the aforementioned high-interest rates. People who have these types of accounts will also be able to enjoy the flexibility in both withdrawals and deposits that a normal savings account provides.
There is, of course, a limit to the account holder’s ability to earn interest. These types of accounts may also only be accessible to higher earners, with regular workers having to stick with the lower rates that normal accounts offer.
Roth IRA: Advantages and Disadvantages
Tax-free growth is arguably the biggest selling point for Roth IRA accounts. The fact that these accounts can also be shielded from creditors in case of bankruptcy is another big plus.
Withdrawals and the limitations regarding the amount that people can invest in their accounts are the two biggest downsides. There’s also a higher risk rate involved in some of these transactions. That’s something that people may want to consider.
Comparing Investment Returns
It’s hard to make a direct comparison on returns for two reasons. The compounding interest factor in Roth IRA accounts will, in most cases, statistically provide better returns. With more money invested, however, in a high-yield savings account, the results could be better.
In most cases, a Roth IRA will likely perform better, but people who have more money to invest could benefit more from a high-yield savings account.
Making a Choice: Roth IRA or Savings Accounts?
It’s almost time to make a decision, but there are still a few things to go over before picking an account. Most people will have a clear favorite in their minds at this point, but there are still a few elements that could shape the decision.
Key Factors to Consider
The amount of money that a person plans to put into their savings account, Roth IRAs, or any other form of retirement savings is a key factor.
It’s important to remember that savings accounts are essentially only as good as the interest rate that they provide. Some people could be reading this at a very favorable time for these types of accounts, while others may not feel the same.
Folks who are in a tricky financial situation and want to ensure that the money they put into the account is there for the future could benefit more from a Roth IRA.
Determining the Right Account for You
One of the questions that people always have in these savings account vs Roth IRA comparisons revolves around the “safe pick.” The problem is each option features certain elements that can make it safe.
Roth IRA accounts, for example, are protected even if a person files for bankruptcy. However, there’s a higher certainty of getting a return with a savings account. Many people could end up going back and forth with this dilemma for a while.
People who may have access to high-yield savings accounts because of their income level could truly benefit from them. It’s important to keep in mind that there’s no obligation to put all of the money that a person has into the account. Managing multiple options could very well be the best bet.
Considering Financial Goals and Risk Tolerance
Finding the right financial advisors to help navigate the risks and reach the desired financial goals is key in any situation. The biggest problem with a Roth IRA account is putting money into something that’s not providing the desired returns. Even if that money is not taxable income, it should be able to grow beyond the inflation rate in that account.
Investing savings of any kind in the stock market, for example, could be a proposition that’s way too risky for some tastes. Then again, having a more diverse portfolio could be beneficial in the end. The problem is any decision will have to take into account the risk that each person is willing to take, plus the amount of money that they’d be able to allocate to any option.
Frequently Asked Questions
Is it better to put money in savings accounts or a Roth IRA?
It depends on the amount of money that each person is willing to invest. There’s a possibility for higher returns with a Roth IRA account, but there’s also a risk of possible loss. People with a lot of money available and who want to play it safe could heavily benefit from the right high-yield savings account.
Those with not as much money and who are willing to swing big could be way better suited going with a Roth IRA. The best-case scenario is actually being able to open both types of accounts.
Should I use a Roth IRA as a savings account?
This could be a good idea for people who are willing to not have access to their money for a long time. It’s important to keep in mind that Roth IRA accounts will only allow withdrawals without fees after a person turns 59 and a half. If the idea behind having a “savings account” involves withdrawing money constantly, then no, having a Roth IRA wouldn’t be a good idea.
What is the downside of a Roth IRA?
There are three main points that people tend to take issue with when it comes to Roth IRA accounts. One of them is the limits to the amount of money that can go into the account. The second issue is the restrictions when it comes to withdrawals, and the final problem is the risks involved.
Can I move money from a savings account to a Roth IRA?
This is something that technically can be done. It depends on the financial institutions that host both accounts. There may be a particular process that you have to go through to be able to transfer money from savings accounts. The account manager at the credit union or bank can quickly help anyone through that process.
Are Roth IRAs insured?
Yes, these accounts are insured by the Federal Deposit Insurance Corporation, but there’s a limit of about 1.5 million dollars that the insurance covers. The great thing about IRA accounts is that they can be protected even if the account holder files for bankruptcy. That’s another element that people may want to keep in mind when choosing the type of account that they want to open.
There are certain elements that could push the decision to pick an account type one way or the other. People who are looking to allocate more than around $7000 per year to retirement savings will have to open other types of retirement accounts besides a Roth IRA. The contribution limits can be a real issue.
The fact, however, that a Roth IRA account is tax-free makes it a must-have, even for people who want to save money beyond the federally imposed limits of an IRA. It’s also important to point out that the interest earned with regular savings accounts may not be the only thing people will want to consider when opening those accounts.
Different financial institutions could feature unique regulations when it comes to the number of times that a person can withdraw money from their savings account, for example. Although most banks that offer the possibility to open savings accounts allow holders to withdraw six times a month with no penalty, that’s not a general rule.