Planning your retirement is something every American should take seriously. With life expectancy getting longer and longer thanks to advances in medicine and nutrition, you can expect to live significantly longer than most Americans did just 200 years ago. While this is good news, there is a downside that is rarely talked about. This is the fact that you need to plan well so that you are well provided for in your retirement years. What this means is that you need to pay a lot more attention to your retirement plans to ensure that you have sufficient resources to live comfortably even when you have finally stopped working. Individual retirement accounts or IRAs come with two options: Roth IRA vs. traditional IRA. Here is a look at these two options and a discussion about which best suits your needs.
Understanding Individual Retirement Accounts
Individual retirement accounts or IRAs are financial instruments that enable Americans to save for their retirement. They incorporate special tax benefits that ensure that you can accumulate wealth that will help you in your golden years. Many Americans often wonder what is the difference between saving for retirement through ordinary savings accounts and using these special savings accounts. The key difference lies in the tax benefits that you get when you save for your retirement using IRAs. The fact that some of these IRAs enable you to make withdrawals without any taxes or penalties means that you can end up with a substantially bigger nest egg than would be possible if you were using other financial instruments to save for your retirement.
Apart from this, IRAs, whether the traditional version or Roth, allow you to make contributions that are tax-deductible, which means you get to lower your tax-deductible income every year that you contribute to your retirement using these versatile instruments. Another reason why IRAs are different from other financial instruments that you can use to save money is that eligibility is very broad. In most cases, the criterion is simply being able to demonstrate that you have earned income within a specified period.
Investment Options
Apart from just saving money, IRAs give you investment options within the accounts, which enables you to increase the amount of money that you are saving for your retirement beyond what you can contribute. IRAs enable you to invest in stocks, mutual funds, bonds, and many other investment options. In the hands of a skilled investment fund manager, you can considerably expand your nest egg and guarantee yourself a comfortable retirement. These investment options are largely guided by your risk tolerance and your retirement goals, which ensures that you are always in control of your future.
Understanding Traditional IRAs
With traditional IRAs, you get to enjoy tax benefits during the years that you are contributing. Essentially, contributions to these accounts are tax-deductible, which means you get to enjoy a lower tax liability in the years that you are contributing. If you are in a high tax bracket, this can save you a ton of money. The catch with these traditional IRAs is that you will pay tax on any withdrawals that you make from this account as ordinary income. The best way to understand this dynamic is to see the process is being spared of tax liability when you are making the contributions but paying the due tax later when you are making withdrawals from this account.
You will be glad to know, however, that there are mandatory maximum distributions that require account holders to make certain amounts of withdrawals every year when they hit a certain age. These mandatory withdrawals can help to lower your tax liabilities down the road, ensuring that you end up saving money. There is also the possibility of claiming full tax deductions on your traditional IRAs, but it is important to note that is usually subject to specified income limits. If you can show the IRS that you meet this threshold, then you can enjoy a full tax deduction on your IRA contributions.
Understanding Roth IRAs
When it comes to Roth IRAs, the opposite happens. The money that you contribute to your Roth IRA has already been taxed, so there will not be any tax deduction when you are contributing. However, down the road when you are making withdrawals from your Roth IRA account, you get no tax liability on the funds, which can significantly boost the amount of money available in the account. Roth IRAs essentially mean that your retirement money grows tax-free for decades. This includes any investment returns that this money may generate.
Investment funds managing your Roth IRA account may suggest something called a Roth IRA conversion. This essentially means changing your traditional IRA amount into a Roth IRA account. The catch here, however, is that this conversion comes with tax liabilities. Typically, the amount that you convert will be considered by the authorities as taxable income for that year. Certain income thresholds must be subject to tax breaks, so people who are in this category can simply contribute directly to their Roth IRA account. An investment expert will help you determine where you fall within these tax brackets and help you make an informed decision.
Which Option Is Best for You?
Like many things in the investment world, the choice of what works best for you when choosing between a Roth IRA vs. traditional IRA depends a lot on your circumstances as well as your goals.
- If you are currently in a high tax bracket, traditional IRAs are appealing as they lower your tax liability and ensure that you push the tax bill down the road. However, if you anticipate that you are going to be in a lower retirement bracket when you retire, the tax-free element of Roth IRAs can be a lot more appealing.
- Another factor to consider is when you anticipate to retire. If you have a long way to go before you retire, a Roth IRA is a lot more appealing, as it means your money has a longer period to grow tax-free. The returns that you make over this period may easily offset any tax liabilities that you may have to pay upfront.
- If you have alternative sources of income, then a traditional IRA plan may work, as the high tax bill that is liable for such accounts may not hurt as much. However, if your primary source of income during your retirement years is your IRA account, then it is wise to consider a Roth IRA account. This is because traditional IRA accounts are taxed as ordinary income, and this may place a huge tax burden on your only source of income.
The choice that you make when choosing between these two retirement accounts depends on your retirement goals. Working with an experienced investment management firm like Nevada Trust Company can remove the guesswork from this process. We specialize in providing trustee and custody solutions, with a focus on expertise not only in self-directed IRAs but also in asset protection trusts and comprehensive wealth management strategies customized to clients globally and domestically. Our investment experts will help you make the most optimal choice, ensuring that you have a comfortable retirement.
