Wha type of retirement is best – a traditional or Roth? Which one is more tax efficient? Which, Roth or traditional allows you to keep more of your money for retirement?
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retirement planning is an essential aspect of financial planning that everyone should be considering as early as possible. One key decision to make when planning for retirement is whether to go with a traditional retirement account or a Roth retirement account. Both options have their advantages and disadvantages, and the best approach will depend on your individual financial situation and goals.
A traditional retirement account, such as a 401(k) or an IRA, allows you to contribute pre-tax dollars to your account. This means that you can deduct your contributions from your taxable income, reducing the amount of taxes you pay in the current year. The money in a traditional retirement account grows tax-deferred, meaning you don’t pay taxes on the earnings until you withdraw the money in retirement. This can be advantageous if you expect to be in a lower tax bracket in retirement than you are currently.
On the other hand, a Roth retirement account, such as a Roth IRA or a Roth 401(k), allows you to contribute after-tax dollars to your account. This means you don’t get a tax deduction for your contributions in the current year, but the money in a Roth account grows tax-free. This can be advantageous if you expect to be in a higher tax bracket in retirement than you are currently, as you won’t have to pay taxes on the withdrawals.
So, which approach is best for retirement planning? The answer depends on your individual financial situation and goals. Here are some factors to consider:
– Current tax bracket: If you are currently in a high tax bracket, contributing to a traditional retirement account can help lower your taxable income and reduce your tax bill. On the other hand, if you are in a lower tax bracket now, a Roth account may be more beneficial as you can pay taxes on the contributions now at a lower rate compared to the potential tax rate in retirement.
– Future tax bracket: Consider your expected tax bracket in retirement. If you expect to be in a higher tax bracket in retirement, a Roth account may be a better option as you won’t have to pay taxes on the withdrawals. However, if you expect to be in a lower tax bracket in retirement, a traditional account may be more beneficial as you can defer paying taxes on the earnings.
– Withdrawal flexibility: Roth retirement accounts offer more flexibility when it comes to withdrawals. Since you have already paid taxes on the contributions, you can withdraw the contributions at any time without penalty. With a traditional account, you will have to pay taxes and potentially penalties on withdrawals before age 59 ½.
Ultimately, the best approach for retirement planning will depend on your individual financial situation and goals. Consider consulting a financial advisor to help you make an informed decision based on your personal circumstances. Remember, the most important thing is to start planning for retirement as early as possible to ensure a comfortable and secure future.
And don't forget there are other options as well like a taxable brokerage. If you invest in an index ETF with low portfolio turnover like the S&P 500 index in a taxable brokerage most of the distribution amounts would be based on long term capital gains rate which could be zero with some higher earners paying 15% or the higher rate. There are also I-Bonds which I would treat as cash equivalents that adjust for inflation which you can purchase up to 10K per individual annually. The interest earned isn't taxed until you redeem the bonds, but you can do them in smaller increments (minimum of $25) and redeem them as needed or when there is a market downturn.
There is no guarantee that you won't have a financial emergency in your retirement years: Roof replacement, costly prescription drugs not covered by your insurance, dental work, plumbing or HVAC replacement. If you have both and other options then you can mitigate the taxes you pay in the future.
Seems like there would be a psychological reluctance to ever withdraw from a Roth account, since it pays off the most when it's invested for the longest time and not touched. With a traditional IRA it makes sense to have 4 to 6% annual installments and use the money while living. The Roth account might be good for dying with the most money possible. You can't take it with you, so what is that money for? Do you want a college building named after you? It might get renamed in 100 years if future generations find any fault in your history.
I just started a Roth IRA at 50 after paying off my mortgage. So if I need to draw extra in a year for large expenses it won't kick me into a higher tax bracket.
Another youtuber said something that stuck with me. When you're in retirement and depend on that retirement investment, paying that tax will suck. When you are still working its easier to pay the taxes because you aren't spending down your investment.
That said, whichever you choose, try to have the same take home pay. Hence invest extra if doing pre-tax.
I was just watching this video again and paid a bit more attention to the numbers Traditional $66,394 vs. ROTH $61,665. Perhaps some focus need to be placed on when the money is needed more in regards to which route to go. It seems that for many their 20s thru early 50s tend to be when they are raising (supporting) their average 2.5 kids. During those years the $5k difference may mean all the difference in the world (even more so for those with family income less than $60k).
I did both. It is now paying benefits in retirement. I will be able to be in the ZERO tax bracket once I start withdrawing from my retirement accounts. Yes, ZERO income tax. Now that is a plan that worked out.
I have always split mine 50/50 and will continue to do so. Having options is better than not having them. I.e. If I want to take out 100k extra in one year then there is no issue.