Roth IRA Vs Savings Account

Roth IRA Vs Savings Account

Navigating the world of savings and investments is all about being able to understand the offerings that fit you best and the different elements that are essential in each. For example, while the Federal Deposit Insurance Corporation (FDIC) insures bank accounts, the National Credit Union Administration (NCUA) insures those maintained at a credit union.

Knowing where the policies that govern your account insurance originate helps you to understand where alignment with your needs may be.

Similarly, you’ll want to ensure that you use the right accounts for immediate needs vs retirement savings and other goals. With that in mind, below is a look at traditional savings accounts and Roth IRAs.

Understanding Individual Retirement Accounts (IRAs)

Individual Retirement Accounts (IRAs) are types of accounts that allow you to invest your income money into funds you can withdraw in retirement. It is also possible to invest into various other assets, such as precious metals, however you would have to convert your IRA to a Gold IRA. Our comprehensive article can shed more light as we delve into individual retirement accounts and all their types.

Defining a Roth IRA

As the name implies, a retirement account is intended for retirement. There are different types available, one of which is known as a Roth IRA. These are accounts that see contributions coming in from after-tax dollars.

Like the traditional IRA variant, compounding interest applies to Roth IRAs and there are contribution limits to bear in mind. Interestingly, there are no minimum distributions that must be taken, meaning that the money can be left for however long and even may be passed on to beneficiaries.

roth ira tax free contributions

Benefits of a Roth IRA

One of the biggest advantages of using Roth IRA are after-tax dollars upon contribution. This means that when it comes time to withdraw at retirement, there is no tax to deal with.

Next, there’s the fact that the money benefits from tax-free growth, which means that the amount of savings that are possible over time is very significant.

Limitations of a Roth IRA

On the limitation side, there is the fact that the amount that can be contributed to the IRA annually is limited. Furthermore, the income of the account holder is what will determine what that figure looks like.

While not dealing with taxation at retirement time is attractive, Roth IRAs do not have the benefit of being tax deductible, meaning that no tax deduction will be received.

Tax Implications of Roth IRAs

The way Roth IRAs work means that you must consider when you want to deal with taxes. It’s a matter of if you want to handle it at contribution time vs at withdrawal time. This will be based on what you expect your earning potential to look like now vs then.

Exploring Savings Accounts

Defining a Savings Account

Now that you understand Roth IRAs a bit more, it’s a good time to turn the focus to savings accounts. These are deposit accounts that interested parties may open at banks, credit unions, or some other kind of financial institution. The idea behind these accounts is to help you separate the money you wish to spend now from the money that you wish to spend later.

Opening the account will require an initial deposit to be made. That money can then earn interest over time at a bank-set rate that is considered taxable income. Should a need to spend the money arise, the account holder is allowed to make a withdrawal.

There are several types of savings accounts to keep in mind, which are as follows:

  • Traditional savings accounts – These are the standard variety that works as indicated above, where the account holder will deposit money and earn interest. However, the said interest will typically be on the lower end of the fence and bank fees may apply.
  • High-yield savings accounts – As the name implies, the interest rates here are above the average numbers that you would see with a traditional account. Some banks will sweeten the deal by waiving monthly fees.
  • Money market accounts – Such accounts combine checking and savings accounts. While you will be able to earn interest on deposits, access via a debit card or paper check is still possible.
  • Specialty savings accounts – There will usually be a designated purpose for which these kinds of accounts are created. Take a Health Savings Account, for example, that is meant for certain health care expenses.

Advantages of a Savings Account

  1. Savings accounts are typically very easy to open and the deposit that’s required to get it started isn’t very prohibitive.
  2. It’s possible to grow the money in a deposit account over time since the bank or credit union that maintains the account will usually pay some measure of interest.
  3. Withdrawals are very straightforward as there is no complicated process to go through. Additionally, no age barrier would prevent the account holder from doing so before a certain time.
  4. There is a certain level of protection afforded to those who set up savings accounts. Assuming the account is healed at an FDIC member bank, there is protection of up to $250,000 per depositor for each type of account owned.

Disadvantages of a Savings Account

  1. There are no tax benefits to be enjoyed from savings accounts. While the account can be used for retirement purposes, there are also no incentives offered that would encourage this.
  2. While regular savings accounts will accrue interest from institutions that pay it, the rates are typically not very high. Things can be different with online banks, but this is typically the case with traditional banks.
  3. If frequent withdrawals are made, the bank reserves the right to impose fees or even convert the account to a checking account.
  4. Depending on the amount being stored in the account, it becomes possible to lose money for real if there should be a loss incident since there is a protection limit.

Interest Rates on Savings Accounts

Financial advisors will typically tell their clients to have both a savings account and something that generates higher interest. As you can deduce based on the information provided so far, the interest rates that savings accounts offer are not life-changing.

Roth IRA Vs Savings Account: A Comparison

Contribution Aspects

In this section, we will compare the contribution aspects of both Savings account and Roth IRA. If you want to opt for Roth IRA, we have a detailed guide where we dive into the specific limits on Roth IRA contributions.

Roth IRA Contribution Limits

The contribution limits associated with Roth IRAs will change annually, so it’s a good idea to keep abreast of them. 2023 saw a $6,500 contribution limit with an additional $1,000 being allowed for those who are 50 and over. 2024, allows a standard limit of $7,000, with $8,000 being allowed for those who are over 50 years.

Savings Account Contribution Flexibility

One of the good things about savings accounts is the flexibility that they allow in your deposits. If you’re not having a good financial year, for example, you can always deposit what you can afford to.

However, if you’re having a great financial year, you can deposit as much as you desire. There are no limits imposed on the amount that you can deposit as there are with Roth IRAs. Sure, there may be limitations on cash transactions, but this is not a hard limit on electronic transactions.

Withdrawal Regulations

Roth IRA Withdrawal Rules

Roth IRA Withdrawal Rules

A Roth IRA is meant to be a retirement account, which means that the idea is that the account holder will not touch the contents until retirement. Under normal circumstances, such as the case with traditional IRAs, there would be a 10% for early withdrawals.

By understanding Roth IRA withdrawals, a Roth individual retirement account does not have this restriction, as withdrawals are allowed just about whenever of original contributions with no penalty. Be that as it may, unless there is an exception, there will usually not be any allowance for earning withdrawals until the account holder has reached 59 1/2 years old.

Savings Account Withdrawal Flexibility

With savings accounts, there is a little more freedom in the withdrawals that can be made. There isn’t a wait for an age bracket in the first place, and there are no penalties for withdrawals, whether it be of the deposited amount or any interest earned.

Note, however, that banks can and sometimes will impose a limit on the number of withdrawals that can be made monthly. Typically, people will be allowed to exceed the limit, but there will be a fee associated with doing so. Additionally, there will usually be a limit to how much can be withdrawn in a single transaction.

Asset Protection in Both Account Types

If this question was asked before the enactment of BAPCPA, there would be no protection to speak of for holders of Roth IRAs. Before that, federal bankruptcy laws only provided protection for pensions, 401(k) plans, and the like.

Now, up to $1 million of assets that are in Roth IRAs are protected. Thankfully, this figure will also account for inflation as there is a regular adjustment made. The first adjustment was in 2007, with new calculations and enactments coming every three years.

The current three-year period began in April 2022 and has a value of $1,512,350 per person. Note that this figure is not a per-account application. It applies to the sum of all traditional and Roth IRA accounts owned by an individual.

Note also that while there may not be protection for funds beyond that figure by the BAPCPA, if judges decide to grant it, then a bankruptcy court can choose to grant additional protection.

As indicated before, savings accounts have a safety net, provided that the financial institution being used falls under the umbrella of the FDIC. With this in mind, account holders can get protection of up to $250,000.

Evaluating Growth Potential

Let’s see the potential for growth in both account types. Should you wish to learn more, please consult our article to uncover Roth IRA’s growth potential in much more detail.

Roth IRA Growth Potential

The growth potential for a Roth IRA is pretty high considering that it uses a compounding interest calculation type. Beyond that, there isn’t a rate that is just arbitrarily set by an institution that will determine what the appreciation looks like. Instead, the interest earned will be based on what the value of the underlying asset looks like.

Savings Account Growth Potential

While savings accounts offer a measure of safety, they are not the best vehicle for those who are looking to earn significant interest on their funds. The rates applied to these accounts tend to be set by banks and are notorious for being pretty low.

Identifying Similarities and Differences

Common Features of Roth IRA and Savings Accounts

While a Roth IRA and a savings account are different, the two do bear some similarities in the way they work. Here are a few practical examples:

  1. Both accounts can provide a measure of interest and can be used for saving money in the long term. This allows either or both to be used to form a retirement strategy.
  2. It’s possible to open either account type at a bank and it turns out that the deposit amount for either isn’t very high. Note also that Roth IRA CD accounts are offered by some banks. These are accounts that fall under the CD umbrella while using the Roth IRA taxation rules.
  3. Like savings accounts, Roth IRAs that are held at banks are under the protection of the FDIC. This is applicable where the Roth IRA is self-directed and the account owner is the one that makes decisions concerning the account as opposed to a plan administrator.
  4. As you probably know, both adults and children can have regular savings accounts at the bank. What is less commonly known is that it’s possible to open a Roth IRA for a child. This works well for children who may have some kind of income before they reach the age of 18.

Contrasting Roth IRA and Savings Accounts

While there are similarities between the accounts, there are also differences to bear in mind, which is what makes each more applicable to certain kinds of needs than the other. Here are the key differences to remember:

  1. Roth IRAs are meant for retirement savings while savings accounts are useful for just about any short or long-term goal that you may have.
  2. A Roth IRA can be opened by any taxpayer who may fall within certain income brackets while a savings account is opened by adults with a valid ID regardless of what their income status may be.
  3. Savings accounts earn interest based on a rate that is bank-assigned while Roth IRAs will earn compounding interest based on whatever value the underlying investment has.
  4. With a Roth IRA, there is the benefit of 100% tax-free qualified distributions. Additionally, there are no minimum distributions required. Currently, savings accounts do not offer any kind of tax benefits. Any interest is simply counted as taxable income.
  5. Annually, Roth IRAs have a contribution limit while no deposit limit is applied to savings accounts.
  6. No withdrawals are allowed of earnings from a Roth IRA before the account holder is 59 1/2 years old unless some kind of exception is applicable. However, it’s possible to withdraw original contributions whenever. As far as savings accounts go, restrictions from banks will typically come from the number of withdrawals that can be made monthly, as well as the maximum withdrawal amount for transactions.
  7. A Roth IRA is incredibly risky, as is the case with most investment-type ventures. Savings accounts are relatively safe.

High-yield Savings Account Vs Roth IRA

High-yield Savings Account: Advantages and Disadvantages

A high-yield savings account is one option you could consider if you’re looking for an option that presents more where interest rates are concerned. On the beneficial side of the fence, you have the following:

  • The interest rates are the main thing that makes these kinds of accounts attractive. Perhaps you are an investor who is looking to maximize your earning potential.
  • Typically, a greater potential return comes with greater risk. Since high-yield savings accounts don’t have the greatest returns (even considering their position above standard savings accounts), the risk factor associated with them is not too high. This is especially true considering FDIC protection applies here too.

On the downside, there are the following:

  • As indicated before, the returns that you’ll get from this kind of account are not so significant when you compare them to other investment options such as real estate or the stock market.
  • There will be a limit imposed on the number of monthly withdrawals you can do, with fees being applied when the said limit is exceeded.

advantages and disadvantages of roth ira

Roth IRA: Advantages and Disadvantages

Compared to a high-yield savings account, a Roth IRA retains its advantage and disadvantage pool when stacked up against regular savings accounts. The advantages include:

  • There are no minimum distributions that need to be taken after the age of 73, allowing the account holder to have their money grow indefinitely tax-free.
  • Since the contributions come from after-tax dollars, the potential for savings is much greater since the money in the account has no tax implications for its growth.

As far as the downsides go, these are the ones to keep in mind:

  • No tax-deductible contributions exist in Roth IRAs, which means that the receipt of a tax deduction is not on the table.
  • Contributions are limited annually based on the income that the account holder earns.

Comparing Investment Returns

The potential for returns, while not guaranteed will be higher with a Roth IRA since its appreciation is tied to the movements in value of the underlying asset. With a savings account, there will simply be a preset interest rate set by the bank, which represents the return cap. Worse even, this is treated as taxable income.

Making a Choice: Roth IRA or Savings Account?

Key Factors to Consider

None of these options is objectively better than the other. It’s all about the intention behind it. Here are some things you want to think about before you choose:

  • Are these savings meant for the short or long term?
  • What does your risk profile look like?
  • Is safety or potential high appreciation more important to you?
  • How frequently do you plan to make withdrawals?
  • Does being able to contribute in an unlimited fashion matter?

Determining the Right Account for You

The questions above can be used as a template of sorts to help you begin to realize which account is more appropriate.

You may find that you have answers that would make both accounts appealing. Bear in mind that you don’t need to choose one or the other. Perhaps your goals may be best supported by opening a savings account for short-term goals, with a Roth IRA holding retirement savings.

Considering Financial Goals and Risk Tolerance

This sentiment cannot be echoed anymore. Try not to use objective metrics to determine what may be most optimal for you. Take the time to work through your goals and what you can stand to lose. Perhaps consider getting the counsel of a financial advisor.

Frequently Asked Questions

Is it better to put money in a savings account or a Roth IRA?

There isn’t a better place to put money. You may find that your needs align with one, the other, or both.

Should I use a Roth IRA as a savings account?

Technically speaking, you could do so since your contributions can be withdrawn whenever with no penalty. However, as an investment-type account, there is no guarantee that your funds will appreciate.

What is the downside of a Roth IRA?

The major downside is the fact that contribution limits exist based on your income, which limits your growth potential to some extent.

Can I move money from a savings account to a Roth IRA?

You have the freedom to move your money from your savings account to wherever your heart desires. This includes using your savings to get your Roth IRA going.

Are Roth IRAs insured?

Currently, there is insurance for Roth IRAs for up to $1,512,350 per person, thanks to the enactment of BAPCPA. This figure is adjusted every three years for inflation, with the last adjustment happening in 2022 to where it currently stands.

Conclusion

Roth IRAs and savings accounts are two solid options in the world of wealth. The former is good for long-term savings in an account that has the potential to grow tremendously thanks to compounding interest and potentially well-performing underlying assets.

Savings accounts are safer, but will see less growth. They are good for both long and short-term needs. This is what makes them great for holding emergency funds, for example.

Don’t think of one as being greater than the other. Remember that each has its place in financial strategies, some of which may see both being employed.

Use the information provided above to familiarize yourself with the applicability of each and seek the counsel of a financial advisor to ensure that you make the best possible decisions for your needs.

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