How does Ellevest determine whether I should open a traditional or Roth IRA?

What’s the difference between a traditional IRA and a Roth IRA?

Traditional and Roth IRAs are both tax-advantaged accounts designed to help you save for retirement, but there are a few differences between them.

In a traditional IRA, all earnings grow tax free, and contributions may be tax deductible depending on your financial situation. Withdrawals from the account in retirement are typically taxed as income, and withdrawals before 59½ are subject to a 10% penalty from the IRS.

In a Roth IRA, the earnings also grow tax free, but contributions are never eligible for a tax deduction. Unlike a Traditional IRA, when you withdraw from a Roth IRA in retirement, the distributions are usually tax-free. Contributions to a Roth IRA (but not investment earnings) can be withdrawn without penalty at any time. Roth IRA investment earnings can be withdrawn after five years for certain approved reasons, such as a first time home purchase. You can read more about the details on the IRS website here.

Both traditional and Roth IRAs are subject to contribution limits.

How does Ellevest make its initial IRA recommendation?

Our recommendation on whether you should open a traditional IRA or a Roth IRA for your Retirement goal is based on our estimate of your eligibility to contribute to a Roth IRA. This estimate is based upon the salary you provided to us (or the household income, if you’re married).

If the salary (or household income, if filing jointly) that you entered is greater than the current year’s IRS allowed income limits for contributing to a Roth IRA, we will recommend that you open a traditional IRA.

If the salary (or household income, if filing jointly) that you entered is less than the current year’s IRS allowed income limits for contributing to a Roth IRA, we estimate your retirement forecast with a Roth IRA and your retirement forecast with a traditional IRA, and then recommend the account type with the higher forecast.

We assume that future tax rates are the same today as in retirement, and make assumptions about your taxes based upon your salary and state of residence.

Our forecasts are determined using a Monte Carlo simulation—a forward looking, computer-based calculation in which we run portfolios through hundreds of different economic scenarios to determine a range of possible outcomes. The forecasts that we compare have a 70% or more likelihood of achievement, and include an Ellevest advisory fee of 0.50% and the impact of inflation.  

What are the limitations of our recommendation?

Our recommendation does not consider other income that you or your household may have outside of the salary and household income amounts you provided to us. For example, we do not consider the impact of investment income such as interest, dividends, and capital gains, or other income such as a pension or alimony. The addition of such income may cause you to become ineligible to contribute to a Roth IRA and/or may result in a different recommendation.

Our recommendation also does not consider your specific tax information or any information you may know about your taxes in retirement. Because your eligibility to contribute to a Roth IRA depends upon all of your income sources, as well as your specific tax information, you should consult with your tax advisor to determine which IRA is most suitable for you.

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