Personal Finance and Wellness
Are you saving for retirement? Are you confused about all of the different terminologies used
for retirement accounts: Traditional IRA, Rollover IRA, Roth IRA, Roth 401k, Traditional 401k.
What do they all mean? What are the differences? Which is best for you?
In a Traditional IRA, your contributions are tax-deductible and you will pay taxes on the
withdrawals you make when you retire. This is an account you open on your own through a
brokerage or bank, not through your employer. A Traditional 401k is through your employer
and contributions are made prior to taking taxes out of your check so your payroll tax is less.
You haven’t paid taxes yet on this money. When you take withdrawals out in retirement you will
pay the tax on it. A Rollover IRA is when you leave an employer and you take the money out of
your 401k and roll it over into an IRA with a brokerage or bank.
The Roth IRA was introduced under the Taxpayer Relief Act in 1997. The main advantage is
its tax structure. Contributions to a Roth IRA are made from earned income that has already
been taxed. Since you have already paid taxes on the money, you don’t pay federal taxes
when you make withdrawals from your Roth IRA. You also don’t pay capital gains tax on any
earnings your investments made in the account. There are several advantages with a Roth IRA.
The Roth 401k was introduced starting January 2006 under the Economic Growth and Tax
Relief Reconciliation Act of 2001. It is different from the traditional 401k because you make
the contributions to it after-tax. It is very similar to the Roth IRA. Any withdrawals or earnings
will not be subject to tax. Not all employers offer a Roth 401k. If your company does not offer
one, encourage them to get one setup. Matching contributions from your employer will be
deposited into a traditional 401k so if you elect to contribute to a Roth 401k you will also still
need a traditional 401k for the matching funds and they will be taxed when you withdraw them.
Unlike Roth IRAs, you will need to take minimum required distributions from your Roth 401k
when you reach 70 and one-half.
Most advisors suggest your retirement savings should start with a 401k up to the company
match. Then open and contribute to a Roth IRA – there are income limitations so check those
out if your income is high. Once you have maxed out the Roth IRA, then go back and max out
your 401k at work. If you still have more that you can contribute to your retirement, then open a
Traditional IRA. If you leave your employer it is usually best to rollover your old 401k over into
a rollover IRA. That will give you more investment options and more control over your money. If
the value of your 401k is less than $5000 you old employer will usually require you to take it
out. Don’t cash it out no matter how small it seems or you will owe taxes and penalties. Even a
little bit from an old 401k can turn into a lot with time and compounding.
If your employer offers both a 401k and a Roth 401k how do you decide which to go with? My
favorite calculator for determining the answer to that question is at Smartmoney.com. It all
depends mostly on whether you think your taxes will be higher when you retire and with all of the
bailouts these days what is your guess? If you are a young investor earning a lower income it
is probably better to go with the Roth 401k as your income hopefully will go up as will your tax
rate. For more info on the current guidelines, tax tables and tax laws regarding retirement
accounts visit this retirement site.
If you have a pool of tax-free retirement money (Roth IRA, Roth 401k) along with a pool of
taxable money (Traditional IRA, Rollover IRA, Traditional 401k), then when the time comes in
retirement to withdraw money you have a choice of which pool is better to tap first, based on
the economics and tax situation at the time.
For more on investments and investing visit Morningstar.com and try their Investing Classroom
on the Personal Finance tab after you sign up for a free trial - cancel anything before the trial
ends and you pay nothing. The classroom is available even after you cancel.
for retirement accounts: Traditional IRA, Rollover IRA, Roth IRA, Roth 401k, Traditional 401k.
What do they all mean? What are the differences? Which is best for you?
In a Traditional IRA, your contributions are tax-deductible and you will pay taxes on the
withdrawals you make when you retire. This is an account you open on your own through a
brokerage or bank, not through your employer. A Traditional 401k is through your employer
and contributions are made prior to taking taxes out of your check so your payroll tax is less.
You haven’t paid taxes yet on this money. When you take withdrawals out in retirement you will
pay the tax on it. A Rollover IRA is when you leave an employer and you take the money out of
your 401k and roll it over into an IRA with a brokerage or bank.
The Roth IRA was introduced under the Taxpayer Relief Act in 1997. The main advantage is
its tax structure. Contributions to a Roth IRA are made from earned income that has already
been taxed. Since you have already paid taxes on the money, you don’t pay federal taxes
when you make withdrawals from your Roth IRA. You also don’t pay capital gains tax on any
earnings your investments made in the account. There are several advantages with a Roth IRA.
- With a Roth IRA you can withdraw all of your contributions (but not your earnings) at any
point in time without having to pay the 10% early withdrawal penalty or any federal
income taxes. On tax-deferred accounts you will pay the penalty and the taxes. - The Roth IRA does not force you to take distributions when you reach 70 and one-half
years of age. On tax-deferred accounts you must take minimum required distributions
after the age of 70 and one-half. So if you would like to and can afford to, you can leave
this account to your heirs. - The Roth IRA allows the account owner to withdraw up to $10,000 without any penalty in
order to purchase a home or principal residence, if they haven’t owned a home for at
least 24 months. - If you expect to be in a higher tax bracket when you retire, it is to your advantage to
contribute the maximum amount towards a Roth IRA. The money invested in a Roth IRA
will have been taxed at the current lower tax bracket and it will not be taxed when it is
withdrawn at retirement. I think this is an important benefit to the Roth. With the current
economic situation with the bank bailouts, insurance company bailouts, auto industry
bailouts, ongoing wars and the future Social Security troubles – do you really think your
taxes have a chance of being lower in years to come? I also think some people reason
that when they retire they won’t have any “income” as they won’t be working so they
assume that they will be in a lower bracket. When you retire you will be pulling out of your
retirement accounts in order to pay your bills. For example, if you need $50,000 for
living expenses now and think you will need about the same in retirement, you will need to
take that $50,000 out of your retirement account each year. If it is in a tax-deferred
account (traditional IRA or 401k) you will need to pay taxes on what you take out. So you
will need to withdraw more than the $50,000 in order to cover the taxes. If you had a Roth
account you can pull it out without paying any taxes.
The Roth 401k was introduced starting January 2006 under the Economic Growth and Tax
Relief Reconciliation Act of 2001. It is different from the traditional 401k because you make
the contributions to it after-tax. It is very similar to the Roth IRA. Any withdrawals or earnings
will not be subject to tax. Not all employers offer a Roth 401k. If your company does not offer
one, encourage them to get one setup. Matching contributions from your employer will be
deposited into a traditional 401k so if you elect to contribute to a Roth 401k you will also still
need a traditional 401k for the matching funds and they will be taxed when you withdraw them.
Unlike Roth IRAs, you will need to take minimum required distributions from your Roth 401k
when you reach 70 and one-half.
Most advisors suggest your retirement savings should start with a 401k up to the company
match. Then open and contribute to a Roth IRA – there are income limitations so check those
out if your income is high. Once you have maxed out the Roth IRA, then go back and max out
your 401k at work. If you still have more that you can contribute to your retirement, then open a
Traditional IRA. If you leave your employer it is usually best to rollover your old 401k over into
a rollover IRA. That will give you more investment options and more control over your money. If
the value of your 401k is less than $5000 you old employer will usually require you to take it
out. Don’t cash it out no matter how small it seems or you will owe taxes and penalties. Even a
little bit from an old 401k can turn into a lot with time and compounding.
If your employer offers both a 401k and a Roth 401k how do you decide which to go with? My
favorite calculator for determining the answer to that question is at Smartmoney.com. It all
depends mostly on whether you think your taxes will be higher when you retire and with all of the
bailouts these days what is your guess? If you are a young investor earning a lower income it
is probably better to go with the Roth 401k as your income hopefully will go up as will your tax
rate. For more info on the current guidelines, tax tables and tax laws regarding retirement
accounts visit this retirement site.
If you have a pool of tax-free retirement money (Roth IRA, Roth 401k) along with a pool of
taxable money (Traditional IRA, Rollover IRA, Traditional 401k), then when the time comes in
retirement to withdraw money you have a choice of which pool is better to tap first, based on
the economics and tax situation at the time.
For more on investments and investing visit Morningstar.com and try their Investing Classroom
on the Personal Finance tab after you sign up for a free trial - cancel anything before the trial
ends and you pay nothing. The classroom is available even after you cancel.
| This site is for informational purposes only. Lillian is not a financial advisor, and nothing on this site should be construed as financial advice. www.debtandmoneyinfo.com - Personal Finance and Wellness |
Making Sense of IRAs, Roth IRAs, 401ks and Roth 401ks