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Traditional and Roth IRAs | Simple Steps for a Retirement Portfolio Course - YouTube
Channel: TD Ameritrade
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If you're saving for retirement, IRAs, also
known as Individual Retirement Accounts, can
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offer significant tax advantages.
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This video focuses on how to choose between
two common types of IRAs: traditional and
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Roth.
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Each provides different tax benefits.
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In a taxable investment account, you have
to pay annual taxes on any profits you earn,
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which can slow the growth of the account.
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A benefit of both traditional and Roth IRAs
is that your earnings aren't taxed while
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they're in the account, which can help your
investments compound.
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Where traditional and Roth IRAs differ is
when you get tax breaks.
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You essentially have a choice of receiving
a tax deduction now or tax-free withdrawals
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later.
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Let me explain.
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With a traditional IRA, your contributions
may be tax deductible.
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This means you may get a tax break in the
years you contribute to the account.
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But, you still have to pay taxes sometime.
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With a traditional IRA, you pay taxes on money
you withdraw from the account during retirement.
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Essentially, choosing a traditional IRA means
you'll pay taxes in retirement, but you
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may get a tax deduction now.
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Now, let's talk about Roth accounts.
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With a Roth IRA, contributions are not tax
deductible, meaning you don't get a tax
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break when you make contributions.
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Once you contribute money to a Roth IRA, you
won't have to pay taxes on your withdrawals
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during retirement.
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So choosing a Roth account means getting a
tax break later.
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So which one is better?
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It depends.
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Based on your personal circumstances, it's
possible that one type of account might be
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better for you.
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The biggest factor is whether you think your
tax rate during retirement will be higher
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or lower than your tax rate during the years
you're contributing.
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If you think your taxes are higher now than
they'll be when you retire, a traditional
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IRA might be better.
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For example, by retirement, your mortgage
may be paid off or maybe your kids will be
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out of the house, so you'll need less income.
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With this lowered income during retirement,
your tax rate may be lower.
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A traditional IRA would allow you to pay taxes
in retirement and take advantage of the lower
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tax rate rather than paying a higher tax rate
now.
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On the other hand, a Roth IRA may be the best
choice if you think your tax rate could be
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higher during retirement.
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For example, if you're a young investor
who's just starting a career, you may expect
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to pay higher taxes later in your career and
into retirement.
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By choosing to pay taxes now at a lower tax
rate, you may benefit by paying less than
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you would in retirement.
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Plus, you'll have the comfort of knowing
you'll be unburdened by taxes when you withdraw
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from your Roth IRA during retirement.
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However, there are a few things to remember.
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First, it can be very difficult to predict
future tax rates.
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As a result, many experts recommend contributing
to both a traditional and a Roth account as
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a way to diversify your tax savings.
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Second, if you think you'll need to access
money in your IRA before you retire, a Roth
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IRA may be a better choice.
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With a Roth IRA, you're able to withdraw
your contributions at any time though if
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you withdraw earnings on those contributions,
they may be subject to income taxes and penalties.
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But with a traditional IRA, many withdrawals
prior to age 59 and a half are subject to
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a penalty and taxes.
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However, some withdrawals for things like
higher education, medical expenses, or the
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purchase of a first home might not be penalized
in certain circumstances.
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Third, there are limits on IRA eligibility
and tax benefits.
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For example, if you already have a retirement
plan through your employer, traditional IRA
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contributions may not be tax deductible.
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And some investors may make too much money
to contribute to a Roth IRA.
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Be sure to check the IRS's income limits
and consult a tax professional.
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While it can be hard to predict your future
tax rate, both traditional and Roth retirement
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accounts can help you maximize your retirement
savings with tax benefits.
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The most important thing is to contribute
early and often.
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