In this video we will discuss the difference between 401K, Roth IRA and Traditional IRA

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LEARN MORE ABOUT: IRA Accounts

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When it comes to retirement savings, individuals have multiple options to choose from. The three most commonly used accounts are 401K, Roth IRA and Traditional IRA. While all three accounts are designed for retirement savings, each has its own benefits and drawbacks. In this article, we will explore the differences between these accounts and help you decide which one is best for you.

401K

A 401K is an employer-sponsored retirement savings account. It allows employees to contribute a portion of their pre-tax income towards their retirement savings, and the employer may also contribute to the employee’s account. 401K contributions are tax-deductible, which means that the money you contribute is not included in your taxable income. This reduces your taxable income, which results in less income tax paid.

One of the biggest advantages of a 401K is that the contribution limit is quite high. In 2021, the limit is $19,500, and if you are over 50 years old, you can contribute an additional $6,500. Furthermore, some employers match contributions, which can help accelerate the growth of your savings.

There are some drawbacks to a 401K, however. One is that you cannot withdraw the money until you are at least 59 and a half years old. If you withdraw the money before the age of 59 and a half, you may have to pay a penalty. Additionally, since 401K contributions are taxed when withdrawn, you may be subject to higher income taxes in retirement.

Traditional IRA

A Traditional IRA is a personal retirement savings account that allows you to make contributions with pre-tax dollars. This means that your contributions are tax-deductible, which can help reduce your taxable income. Additionally, the money in the account grows tax-free until you withdraw it.

The contribution limit for a Traditional IRA in 2021 is $6,000 if you are under 50 years old, and $7,000 if you are over 50 years old. One of the advantages of a Traditional IRA is that it offers a wide range of investment options, allowing you to customize your portfolio to your liking.

However, there is a downside to Traditional IRA accounts. When you withdraw money from the account, it is subject to income tax. Additionally, you are required to start taking Required Minimum Distributions (RMDs) at age 72.

Roth IRA

A Roth IRA is another personal retirement savings account. However, the main difference between a Roth IRA and a Traditional IRA is the tax treatment. With a Roth IRA, you make contributions with after-tax dollars. This means that you pay tax on the money now, but all future withdrawals are tax-free, including any investment earnings.

In 2021, the contribution limit for a Roth IRA is $6,000 if you are under 50 years old, and $7,000 if you are over 50 years old. Another advantage of a Roth IRA is that there are no RMDs, which means that you can keep your money in the account for as long as you like.

The downside to a Roth IRA is that there are income limits, which means that if you earn more than a certain amount, you may not be eligible to contribute to a Roth IRA.

Which one is best?

So, which account is best for you? The answer depends on your individual circumstances. If your employer offers a 401K match, it’s a good idea to contribute enough to receive the maximum match – this is free money.

If you want tax-free withdrawals in retirement, a Roth IRA may be the best choice. If you are in a high tax bracket now and expect to be in a lower tax bracket in retirement, a Traditional IRA may be the better option.

In the end, it’s important to consult with a financial advisor to determine which account is best for you based on your individual financial situation and retirement goals.