March 23, 2015
Why should you consider your tax situation before selecting between a traditional or a Roth retirement plan at work?
Why should you consider your tax situation before selecting between a traditional or a Roth retirement plan at work?
When decided between a roth and traditional you need to look at if you want to pay taxes now or latter. In the Roth you are paying taxes on your earning right now to not pay taxes on the capital gains that money makes. While in a traditional you are delaying paying taxes you would pay on the money that goes in to the account when it comes out. If you are making a lot of income a traditional is likely better for you because you will get more of a benefit off of delaying your taxes and not paying them that year. While the Roth is good for lower income people who will likely be making more latter in life.
You should consider your tax situation because in a traditional IRA, money goes in before tax, and in a Roth IRA, money goes in after tax. Someone with a larger paycheck might benefit more from traditional for the before-tax benefits, and someone with a smaller paycheck may go with the Roth instead, as their tax burden isn’t as great.
Taxes take away your money reducing your wealth. Investing in a Traditional retirement plan can reducte your taxes at the present time. A Roth will have you paying taxes now but it will grow tax deferred until you withdraw the money which allows you to pay no taxes at that time. Both are good. It’s difficult to guess how tax laws will change between now and when you retire. If you are in a lower tax bracket now and already pay little or no taxes a Roth is very benefficial as you’d get no further tax incentives from a traditonal retirement plan. A traditional is useful if you make a lot of money and pay higher taxes now, especially if you have a long time until retirement. If you assume an 8% growth per a year you get a doubling of your money every 9 years. If you have multiple groups of 9 years before you retire you’re money will grow many times over and while you’ll have a lot more you’ll only pay the taxes once it’s withdrawn. Untimately each situation is unique and you should do some research for your individual retirement situation considering taxes now and taxes at retirment to maxamize the money in your pocket to bring youself freedom!
You three are spot on with this question. Let’s review.
(1) Traditional plans are funded with pre-tax money. Roth plans are funded with after tax money.
(2) Consider traditional plans when your income is relatively high. Consider Roth plans when your income is relatively low.
(3) Relatively high and relatively low are rather vague so here is a number to work from. $60,000. If you are single and make more than that, consider the traditional. If you are single and make less than that, consider the Roth. Married people can double those amounts. Just keep in mind, this is not a perfect science.
(4) It all comes down to your future tax rates. If you think they will be higher in the future, consider the Roth today. If you think they will be lower in the future, consider the traditional today. Yes, this takes a bit of psychic ability in trying to see the future. It’s not easy and I realize that.
(5) Pause and make an informed decision BEFORE investing in your retirement plan at work. More and more companies are offering both options. Make the right call based on your particular situation. Financial freedom may follow!