Introduction
When it comes to your retirement savings, choosing the correct type of retirement account is incredibly important for future financial success. Two of the most common options to choose between are Traditional IRAs and Roth IRAs, where the first is tax-deferred while the second is taxed now. In this blog, we will break down the primary differences between these two retirement savings accounts and scenarios where one would be the better option of the two.
Pretax Retirement Accounts (Traditional IRA)
One of the most common retirement savings tools is an employee-sponsored, tax-deferred Traditional Individual Retirement Account (IRA). With this IRA, your contributions typically are deducted directly from your paycheck before taxes are applied, deducing your taxable income for that contribution year. This contribution amount then grows tax free, and you won’t need to pay taxes until you have started distributions. This usually starts once you have reached retirement age.
Traditional IRAs can be beneficial for those who expect to be in a lower tax bracket once they retire, meaning their income will likely be taxed at a smaller rate when deferred. Usually, your typical investments that you want in a Traditional IRA are interest-generating investments, including bonds, where the tax deferral can enhance long-term compounding for the contribution.
Roth Retirement Accounts (Roth IRA)
When you choose to wrap your IRA into a Roth, your contributions are made with after-tax amounts, so you won’t receive an immediate tax deduction. The benefit here, however, is that your taxed contributions can then grow and be distributed tax-free once you are in retirement.
If you want to build a significant retirement nest egg and expect to be in a higher tax bracket at that point, wrapping your investments within a Roth may be the better option. This account option can especially be more preferable for aggressive stocks and investment since the future gains can be withdrawn tax-free. Your first qualified distribution from a Roth IRA must be after five years of your first contribution, and you must have either reached the age 59½, become permanently disabled, or the distribution had been given to your beneficiaries following your death.
Conclusion
With this information on the differences between a Traditional and Roth IRA, you may now be able to better determine how to better protect your retirement savings and pay the least possible amount of taxes. It’s important to research extensively on the subject and look into your personal situation.
Interested in researching more about tax strategy in retirement? Read Capital City Financial Partners’ Founder, Josh Bradley’s, new book titled “Mission: Tax Zero” now.
Want to speak with an advisor one-on-one about what is the best current tax strategy for you and your personal retirement plan? Schedule now.
TIAA – “After-tax Roth vs pretax plan contributions: Which is right for you?”
