Looking to buy a house in 1-2 years. Does starting a Roth IRA now make sense?
With a Roth IRA, you can withdraw the contributions at any time without penalty as long as you don't withdraw the earnings/interest. There are some circumstances where you can withdraw the earnings such as disability (and maybe first home). Also, the Roth IRA doesn't need to go through your employer and I wouldn't do it through your employer. I have mine setup through Fidelity though I'm not sure if they have any guaranteed 3% return unless it was a CD. All of mine is in stocks. Your wife could also setup a Roth IRA so over 2 years, you could contribute $20,000. If I was you, I would just max out any 403-b matches (which you surely are at 25% of gross income) and then save my down payment money in a normal money market/savings account. You are doing good contributing almost 25% to the 403-b. There are also some income limitations on Roth IRAs. I believe for a married couple, it is $160k. If you are going to be buying a house in 1-2 years, I would be putting my money into a short term holding area like a high interest (which isn't that high right now) or a CD (also low interest) because of your near-term need.  I wouldn't use the Roth option for your down payment money. If you invest in something volatile (and stocks/mutual funds are very volatile in a 1-2 year term) I would consider it too risky for your need and time frame. First, look at the local housing market, and the price to rent ratios. If you are comfortable that a house can be had for near to the cost of renting, and are not still dropping is price, then focus on the down-payment. I don't imagine housing prices to start picking up any time soon, so you don't be too rushed. If you feel like you have a longer time to save before you want to buy, I would focus as much money as I can into a retirement account while still saving for a down payment. Since you are young, you really want your retirement accounts working for you as soon as possible. You should not be investing in 3% stable funds, but the stock market index funds. Retirement is for 40 years in the future. Using funds for a down-payment from a retirement account should be a last resort. Remember this money is to provide you security later in life, not to get you into a house. When you take out money and put it into a house, it will not be appreciating nearly as fast. It is easy to say you will save later, but the money you save early in life will make up 50% or more of your funds when you retire. That is why it is critical to save for retirement as soon as possible. Lets do the math (assuming a lot of stuff, like your interest rates and that you make the contribution at the beginning of the year, also your tax bracket at the withdrawal time frame.) 1.) Beginning of year 1 Roth Option $5k contribution Non Roth Option $5k contribution 2.) Beginning of year 2 Roth Option $5000 + $150 interest + 5K contribution = $10150 Non Roth Option $5000 + $75 interest + 5K contribution = $10075 3.) End of year 2 Buy a house! yay! Roth Option---before withdrawal account value = 10150+10150*.03=10454.5 after withdrawl (assuming 38% tax on earnings withdrawal (10%penalty + 28% income tax estimate.) = 10327.17 Non Roth Option = 10 226.125 So you are talking about a significant amount of paperwork to either 1.) Net yourself $100 toward the purchase 2.) Cost yourself $226 on the purchase but have $454.50 in your roth ira. I am not sure I would do that, but it might be worth it.
"So you are paying taxes on your contributions regardless, the timing   is just different. I am failing to see why would a person get an IRA, instead of just   putting the same amount of money into a mutual fund (like Vanguard) or   something like that. What am I missing? You are failing to consider the time value of money. Getting $1 now is more valuable to you than a promise to get $1 in a year, even though the nominal amount is the same. With a certain amount of principal now, you can invest it and it will (likely) grow into a bigger amount of money (principal + earnings) at a later time, and we can consider the two to have approximately equivalent value (the principal now has the same value as the principal + earnings later). With pre-tax money in Traditional IRA, the principal + earnings are taxed once at the time of withdrawal. Assuming the same flat rate of tax at contribution and withdrawal, this is equivalent to Roth IRA, where the principal is taxed at the time of contribution, because the principal now has the same value as the principal + earnings later, so the same rate of tax on the two have the same value of tax, even though when you look at nominal amounts, it might seem you are paying a lot less tax with Roth IRA (since the earnings are never ""taxed""). With actual numbers, if we take a $1000 pre-tax contribution to Traditional IRA, it grows at 5% for 10 years, and a 25% flat rate tax, we are left with $1000 * 1.05^10 * 0.75 = $1221.67. With the same $1000 pre-tax contribution (so after 25% tax it's a $750 after-tax contribution) to a Roth IRA, growing at the same 5% for 10 years, and no tax at withdrawal, we are left with $1000 * 0.75 * 1.05^10 = $1221.67. You can see they are equivalent even though the nominal amount of tax is different (the lower amount of tax paid now is equivalent to the bigger amount of tax later). With a taxable investment which you will not buy and sell until you take it out, you contribute with after-tax money, and when you take it out, the ""earnings"" portion is subject to capital-gains tax. But remember that the principal + earnings later is equivalent to the principal now, which is already all taxed once, and if we tax the ""earnings"" portion later, that is effectively taxing a portion of the money again. Another way to look at it is the contribution is just like the Roth IRA, but the withdrawal is worse because you have to pay capital-gains tax instead of no tax. You can take the same numbers as for the Roth IRA, $1000 * 0.75 * 1.05^10 = $1221.67, but where the $1221.67 - $750 = $471.67 is ""earnings"" and is taxed again at, say, a 15% capital-gains rate, so you lose another $70.75 in tax and are left with $1150.92. You would need a capital-gains tax rate of 0% to match the advantage of the pre-tax Traditional IRA or Roth IRA. After-tax money in Traditional IRA has a similar problem -- the contribution is after tax, but after it grows into principal + earnings, the ""earnings"" part is taxed again, except it is worse than the capital-gains case because it is taxed as regular income. Like above, you can take the same numbers as for the Roth IRA, $1000 * 0.75 * 1.05^10 = $1221.67, but where the $471.67 ""earnings"" is taxed again at 25%, so you lose another $117.92 in tax and are left with $1103.75. So although the nominal amount of tax paid is the same as for pre-tax money in Traditional IRA, it ends up being a lot worse. (Everything I said above about pre-tax money in Traditional IRA, after-tax money in Traditional IRA, and Roth IRA, also applies to pre-tax money in Traditional 401(k), after-tax money in Traditional 401(k), and Roth 401(k), respectively.) Regarding the question you raise in the title of your question, why someone would get contribute to a Traditional IRA if they already have a 401(k), the answer is, mostly, they wouldn't. First, note that if you merely have a 401(k) account but neither you nor your employer contributes to it during the year, then that doesn't prevent you from deducting Traditional IRA contributions for that year, so basically you can contribute to one or the other; so if you only want to contribute below the IRA contribution limit, and don't need the bigger 401(k) contribution limit, and the IRA's investment options are more attractive to you than your 401(k)'s, then it might make sense for you to contribute to only Traditional IRA. If you or your employer is already contributing to your 401(k) during the year, then you cannot deduct your Traditional IRA contributions unless your income is very low, and if your income is really that low, you are in such a low tax bracket that Roth IRA may be more advantageous for you. If you make a Traditional IRA contribution but cannot deduct it, it is a non-deductible Traditional IRA contribution, i.e. it becomes after-tax money in a Traditional IRA, which as I showed in the section above has much worse tax situation in the long run because its earnings are pre-tax and thus taxed again. However, there is one good use for non-deductible Traditional IRA contributions, and that is as one step in a ""backdoor Roth IRA contribution"". Basically, there is an income limit for being able to make Roth IRA contributions, but there is no income limit for being able to make Traditional IRA contributions or for being able to convert money from Traditional IRA to Roth IRA. So what you can do is make a (non-deductible) Traditional IRA contribution, and then immediately convert it to Roth IRA, and if you did not previously have any pre-tax money in Traditional IRAs, this achieves the same as a regular Roth IRA contribution, with the same tax treatment, but you can do it at any income level." "1) Usually, the choice between Traditional vs. Roth is whether you believe that your tax rate will be higher or lower in the future than it is now. Your income is probably in the 25% bracket now. It's hard to say whether that should be considered ""high"" or ""low"". Some people advocate Roth only for 15% bracket; but your income would probably go into higher brackets in the future, so Roth may be preferable from this point of view. Roth IRA also has another advantage that the principal of contributions can be taken out at any time without tax or penalty, so it can serve as an emergency fund just as well as money in taxable accounts. Given that you may not have a lot of money saved up right now, this is useful. 2) In a sense, it's nice to have a mix of Traditional and Roth when you withdraw to hedge against uncertainty in future tax rates and have the option of choosing whichever one is advantageous to withdraw when you need to withdraw. That said, you will likely have many years of access to a 401k and high income in your future working years, in which you can contribute to a Traditional 401k (or if no access to 401k, then Traditional IRA), so a mix will almost certainly happen even if you go all Roth IRA now. 3) I think that depends on you, whether you are a hands-on or hands-off kind of investor." Is there any benefit to investing in a Roth 401(k) plan, as opposed to a Roth IRA?  They have separate contribution limits, so how much you contribute to one does not change the amount you can contribute to the other.  Which is relevant to your question because you said  the earnings on that account compounded over the next 40 years growing tax-free will be much higher than what I'd save on current taxes on a traditional 401(k).   This is only true if you max out your contribution limits.  If you start with the same amount of money and have the same marginal tax rate in both years, it doesn't matter which one you pick.   Start with $10,000 to invest.  With the traditional, you can invest all $10,000.  With the Roth, you pay taxes on it and then invest it.  Let's assume a tax rate of 25%.  So invest $7500.   Let's assume that you invest either amount long enough to double four times (forty years at 7% return after inflation is about right).  So the traditional has $160,000 and the Roth has $120,000.   Now you withdraw them.  For simplicity's sake, we'll pretend it's all one year.  It's probably over several years, but the math is easier in a single year.  With the Roth, you have $120,000.  With the traditional, you have to pay tax.  Again, let's assume 25%.  So that's $40,000, leaving you with $120,000 from the traditional.  That is the same amount as the Roth!   So it would make sense to  If you can max out both, great.  You do that for forty years and your retirement will be as financially secure as you can make it.  If you can't max them out, the most important thing is the employer match.  That's free money.  Then you may prefer your Roth IRA to the 401k.   Note that you can also roll over your Roth 401k to a Roth IRA.  Then you can withdraw your contributions from the Roth IRA without penalty or additional tax.  Alternate source.   Beyond answering your question, I would still like to reiterate that Roth or traditional does not have a big effect on your investment unless you max them out or you have different tax rates now versus in retirement.  It may change other things.  For example, you can roll over a Roth 401k to a Roth IRA without paying taxes.  And the Roth IRA will act like it was contributed directly.  You have to check with your employer what their rollover rules are.  They may allow it any time or only at employment separation (when you leave the job).   If you do max out your Roth accounts, then they will perform better than the traditional accounts at the same nominal contribution.  This is because they are tax free while your returns in the other accounts will have to pay taxes. But it doesn't matter until you hit the limits.  Until then, you could just invest the tax savings of the traditional as well as the money you could invest in a Roth. There is a process called a backdoor IRA.   You now have effectively made a Roth IRA contribution in a year where technically you aren't eligible.  You do not have to pay taxes on earnings with a Roth IRA.  You are limited to the normal annual contribution to the IRA (Roth or traditional).   If you don't convert your traditional IRA contribution to a Roth IRA, then you are right.  That gains nothing except enhanced protection in bankruptcy.  Only do this if you are taking advantage of the Roth rollover.   I'm ignoring rolling over a 401k into an IRA, as that doesn't increase the amount you can contribute.  This does.  You can contribute the full $18,000 to the 401k and still make a full contribution to the backdoor IRA.   This is the tax advantaged form of an IRA.  This avoids double taxation.  Let's assume that your investment can go into something with a 5% annual return and you pay a 25% tax rate (doesn't matter as it drops out).  You are going to invest for thirty years and then withdraw.  You initially have $1000 before taxes.   With a regular investment:   You now have $2867.74.   With a pre-tax IRA.   You now have $3241.45 (it is not an accident that this is almost the same as the amount before the capital gains tax in the example without an IRA).   You avoided the $373.72 capital gains tax.  Even though you paid a lot more tax, you paid it out of the gains from investing the original $250 that you would have paid in tax.   This helps you even more if the capital gains tax goes up in the future.  Or if your tax bracket changes.  If you currently are in the 25% bracket but retire in the 15% bracket, these numbers will get even better in your favor.   If you currently are in the 15% bracket and worry that you might retire in the 25% bracket, consider a Roth instead.  It also avoids double taxation but its single taxation is at your current rate rather than your future rate. It is normally a bad idea to cash in retirement accounts to buy a house, in your case it is a horrible idea because you are way behind on saving for retirement. Other fallacies in your reasoning:   My advice, increase the amount you are saving for retirement considerably, and also put some money aside to save for a down payment on a house. Buy the house when you have enough non-retirement money to afford the down payment. If you can't wait that long, buy a house you can afford. It may help to think of it this way: Visualize yourself as a 65 year old retired person with very little income, and living on your retirement account. Would you as a 39 year old ask that person to give you $175,966 (the amount you are talking about withdrawing compounded annually at 6% interest for 25 years with no additional contributions) so that you could put a down payment on a house? Because that is what you would be doing. When you hit retirement age would you kick yourself for making such a decision? Because unless you die young, that person is sitting out there in your future needing that money to live off of. Don't take this the wrong way, but the tone of your question seems like you are looking for support to make what you already know is a bad financial decision. "To keep it simple, I will keep the focus between a Trad IRA and a normal Taxable account (Roth's and 401(k) add more complications that make another problem).  I will also assume, based on the question, that you aren't able to deduct the IRA contributions. Also, a Roth is better in every way than a non-deductible Trad IRA so the ""backdoor Roth"" mentioned in other answers is probably the way to go and this is more of an academic exercise.  Ok, so why bother with the IRA if you're taxed anyway?  Because you aren't taxed as you go! With a normal non-tax-advantaged account you have to pay taxes every year on any realized capital gains and dividends (including fund distributions). Because of the compounding nature of savings, delaying paying taxes is in your best interest.  Simple example:  Taxable Account: IRA Account: Now, this is a very simplified example. If you're more tax-conscious (i.e. more buy-and-holding), you can delay paying some of the long-term cap gains in the taxable account, but any short-term cap gains (including distributions from the underlying funds) will be at your marginal income tax rate.  A few other observations: EDIT: I set up a spreadsheet where each year I deposited $1000 for 35 years. Each year, the balance in the IRA account grows by 5%, but the taxable only by 5%*(1-0.15) = 4.25% due to the effect of taxes. At the end of 35 years, my simulation assumes you pay 15% on all the gains in the IRA, which would likely not be the case, but easier than forecasting through retirement and demonstrates what I'm trying to show. Here's plot showing the balance in the various accounts, the blue is the IRA account, orange the taxable account, and grey is the effective balance of the IRA, after paying taxes on the gains:   And here's a plot of the advantage of the IRA (after paying taxes on the gains), vs the taxable account:  Whether that's worth it to you or anyone depends on some the assumptions in the simulation, especially effective tax rates, and growth rates, as well as any personal issues. Some people may be less likely to raid an IRA account, for example, than a normal account. Conversely, if you have a project coming up, you may need something a bit more liquid than an IRA." I'd suggest waiting until a bit after you are married. To Eagle1's point, even $23,000 is not a huge sum of money.  You didn't make any mention of a desire to buy a home, but if that becomes part of the plan, I'd want every cent of liquidity I can get. I wrote Student Loans and Your First Mortgage to explain why your buying power for the house is lowered by paying that loan. In your case, $5000 is 20% of $25000. For a good 20% down purchase, I'd want those funds available. You also don't mention retirement accounts. Depending on the home purchase timing, I'd start to think about putting aside at least the $5500 per year IRA/Roth IRA maximum. "Your question isn't great, but I will attempt to answer this piece as it seems really the root of your personal finance question: I want to convince my wife to make this move because it will save us   at least 800 month, but she fails to see how buying a second home is   financially sound because we have to lose our savings and we have to   pay interest on our second home. And... Her logic is it will take almost 5 years to get back our down payment   and we have to pay interest as well. So how can this move help our   family financially in the long run? ... Is she right? She is mostly wrong. First, consider that there is no ""ROI"" really on your down payment. Assuming you are paying what your home would sell for the next day, then your ""RIO"" is already yours (minus realtor fees). She is talking about cash on hand, not ROI. I will use an example without taking into account risk of home markets going down or other risks to ownership. Example: Let's say you pay $2800 a month in mortgage interest+principle at 5.5% apr and $200 a month in taxes+insurance on a $360k loan ($400k house). In this example let's say the same house if you were to rent it is $3800 a month. Understand the Opportunity Cost of renting (the marginal amount it costs you to NOT buy). So far, your opportunity cost is $800 a month. The principle of your house will be increasing with each payment. In our example, it's about $400 for the first payment, and will increase with each payment made while decreasing the interest payment (Suggest you look at an amortization table for your specific mortgage example). So, you're real number is now $1200 a month opportunity cost. Consider also the fact that the $400 a month is sitting in a savings account of sorts. While most savings accounts give you less than 1% in returns and then charge taxes on that gain, your home may (or may not be) much higher than that and won't charge you taxes on the gains when you sell it (If you live in it for a period of time as defined by the IRS.) Let's assume a conservative long term appreciation rate of 3%. That's $12k a year on a $400k house. So, now you're at $2200 a month opportunity cost. In this example I didn't touch on your tax savings of ownership. I also didn't touch on the maintenance cost of ownership or the maintenance cost of renting (your deposit + other fees) which all should be considered. You may have other costs involved in renting. For instance: The cost of not being able to fully utilize your rental as your own house. This may be an even simpler and more convincing way to explain it: On the $2800 mortgage example, you will be paying around $19k in interest and $2400 on taxes, insurance = $23k per year (number could be way different in your example). That is basically throw away money you're never getting back. On the rental, 100% of your rent at $3800 a month is throw away money you're never getting back. That's $45,600 a year."