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Roth IRA vs. savings account: what's the difference?
A Roth IRA is a type of retirement account that contains investments chosen by the account holder. Because Roths are designed to help people save money for retirement, there are withdrawal restrictions and income tax requirements set by the IRS.
A traditional savings account is for setting aside money that the account holder is saving for short-term spending goals. Withdrawals can be made from savings accounts at any time without penalty.
At Credit Union of Southern California (CU SoCal), we make it easy to open a Roth IRA.
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What is a Roth IRA?
A Roth IRA is a type of retirement account that allows your monetary contributions and interest earnings to grow tax-free.
Because a Roth IRA account is funded with after-tax dollars, the account will grow tax-free. This is one of the features that makes Roth IRAs so popular. The Internal Revenue Service (IRS) has set income and account contribution requirements, as well as rules regarding when money can be withdrawn from a Roth account. Qualified withdrawals are tax and penalty-free.
What is a savings account?
A savings account, also called a “deposit account,” is available at credit unions, banks, and online financial institutions. Savings accounts typically pay interest on the monthly balance in the account with tiered levels of interest, so the more you save the more earned interest you’ll receive.
Regular savings accounts typically require that a minimum balance be maintained in the account in order to earn interest and a dividend. People who cannot maintain the minimum balance to qualify for earned interest can still open a non-interest-bearing savings account.
Whether you’re saving to buy a home, car, start a business, or pay for college tuition, savings accounts can help you focus your saving efforts and earn interest in the process. A savings account can also be used as overdraft protection for your checking account, as a means to protect against bounced checks if your checking balance goes too low.
Pros and cons of Roth IRAs
You may be wondering, which is better, a Roth IRA or savings account?
Here are some Roth IRA pros and cons to consider:
Pros
Tax-free growth. Both the money you contribute, and your earnings grow tax-free in a Roth IRA.
Tax-free distributions. Because the contributions into your account were already taxed, withdrawals (i.e., distributions) are tax-free.
No required minimum distributions. Unlike a traditional IRA, a Roth doesn’t require you to withdraw your money when you reach a particular age, so your money has more time to grow.
No income tax on inherited Roth IRAs. Beneficiaries are not taxed on a Roth IRA account they inherit.
Penalty-free withdrawals. Roth IRA account earnings may be withdrawn penalty-free and tax-free if the account holder 1) has the account for more than five years and is at least age 59 and one-half. If you withdraw earnings before this age, you will be required to pay income taxes and a 10% early withdrawal penalty on the earnings you withdraw.
No age limits. You can open a Roth account at any age, and you can leave funds in your Roth IRA for as long as you live.
More time to contribute. You can make contributions to your Roth IRA after you reach age 70 and one-half.
Cons
No up-front tax breaks. Because the money deposited is after-tax money (from your income or other earnings) there is no additional tax break.
Contributions are taxed. Qualified distributions (withdrawals) and distributions of earnings contributions aren't subject to tax.
Earnings withdrawal restrictions. Earnings cannot be withdrawn without penalty before age 59 and one-half unless certain exceptions apply.
Income limits. The IRS sets income limits or thresholds, which means if your income exceeds the threshold, you’re not eligible for a Roth IRA.
Low maximum contributions. The annual contribution limit for 2023 is $6,500, or $7,500 if you’re age 50 or older.
Pros and cons of savings accounts
Pros
Access. Account holders can access their money 24/7 in-person or online.
FIDC / NCUA insured. All savings accounts are FDIC/NCUA insured. Accounts held at a bank are insured by the Federal Deposit Insurance Corporation (FDIC). Accounts held at a credit union are insured by the National Credit Union Administration (NCUA). Both FDIC and NCUA insure savings accounts up to $250,000. It’s important to note that the deposit insurance amount of $250,000 is provided per depositor, per FDIC-insured bank, per ownership category.
Liquid asset. Account holders can access their money 24/7 in-person or online.
Liquid asset is one that is basically cash on-hand when you need it.
Low deposit requirement. Most saving accounts can be opened with a minimum opening deposit of $10.
No lock-in period. You do not need to lock in an interest rate. All banks and credit unions provide an interest rate for their savings account offerings, that may fluctuate slightly based on economic factors.
Cons
Low interest rates. Savings account interest rates are typically lower than rates on money market accounts and other investment account options.
Withdrawal limits. Federal Reserve Regulation D requires that an account, to be classified as a ''savings deposit,'' must not permit more than six convenient transfers or withdrawals per month from the account.
Inflation. Because savings accounts tend to earn lower interest than investment accounts, your earnings won’t likely keep pace with inflation.
Compounded interest. This is the way that financial institutions calculate the interest earned an account. If you’re looking to earn high interest dividends there are investment accounts that earn interest in a more financially advantageous way.
Limited insurance. FDIC and NCUA insurance are limited to $250,000 in an account.
How do Roth IRAs compare to savings accounts?
When it comes to Roth IRAs vs. savings accounts, it’s important to recognize these are two completely different types of accounts created to serve different purposes. Roth IRAs are exclusively for helping people save for retirement. Savings accounts are designed to give people quick, easy access to their money.
Contribution limits. While Roth IRAs have annual contribution limits, there is no limit to the amount of money you can have in your savings account.
Investment options. A Roth IRA is not an investment; it is a type of account that holds investments such as stocks, bonds, and mutual funds. A savings account is not an investment account.
Returns. Because a Roth IRA earns income on investments, the account balance will fluctuate as earnings are influenced by economic factors and move with the stock market. Savings accounts aren’t influenced by economic factors. The money you deposit may earn interest and when it does your balance will increase. Of course, any withdrawals you make will decrease your total balance.
Taxes. As we’ve stated earlier in this article, Roth IRAs have specific tax rules. A savings account that earns interest that is considered taxable income.
Savings vs. Roth IRA: Which account type is right for me?
When it comes to choosing between a Roth IRA and a savings account,
start by thinking about your savings goals and whether you need frequent access to your money or if you’re ok with having somewhat limited access to funds.
Keep in mind these are two dramatically different types of accounts, each with a particular purpose.
If you need frequent access to your money, choose a savings account, and if you do not need to access your money choose a Roth IRA.
How to open a Roth IRA account
Anyone can open a Roth IRA at a credit union, bank, brokerage, or other financial institution that offers savings accounts. Opening a Roth IRA is a simple process like opening any other financial account. You will complete an application that includes your name, address and social security number. You will also need to provide a government-issued proof of identification.
Why savvy consumers choose CU SoCal
For over 60 years CU SoCal has been providing financial services, including mortgages, Home Equity Loans, HELOCs, car loans, personal loans, credit cards, and other banking products, to those who live, work, worship, or attend school in Orange County, Los Angeles County, Riverside County, and San Bernardino County.
Please give us a call today at 866.287.6225 today to schedule a no-obligation loan consultation with a CU SoCal Member Services specialist.
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