010: IRA, Roth IRA, 401(k)…What the Heck is the Difference?

We’ve all heard the warnings and are well aware that we should save more for retirement. And now that it’s a new year, it’s a good time to resolve to take concrete steps to do just that.

Before one can take the first step, however, you must have an understanding of these retirement accounts so you can make an educated decision on which one is best for you and your situation. We know there’s a lot of confusion around this topic, so we break it all down for you.

Uncle Sam wants you to save for retirement so much that the federal government has created a number of tax-advantaged retirement accounts, including popular choices such as the 401(k) and individual retirement account. On this episode, Dustin R. Granger, CERTIFIED FINANCIAL PLANNER™ and I explain what you should know when creating your best retirement plan!

What is a Traditional IRA?

One great option for retirement planning is an IRA or Individual Retirement Account. Like the name implies, an IRA isn’t related to your employer – it’s a retirement product you enroll in on your own. Contributions to a Traditional IRA may be tax-deductible and the investment earnings have the opportunity to grow tax-deferred until you make withdrawals during retirement. You can begin making withdrawals from your Traditional IRA at the age of 59.5 years old without having to pay the early withdrawal penalty. You must begin taking withdrawals and paying tax upon those withdrawals (all withdrawals are taxed, including past contributed principal since it was tax-deductible at the time the contribution was made), by the age of 70.5 years old so you can’t accumulate too much money in the tax shelter.

Disclosure: Contributions to a traditional IRA may be tax deductible in the contribution year, with current income tax due at withdrawal. Withdrawals prior to age 59 ½ may result in a 10% IRS penalty tax in addition to current income tax.

A Roth IRA explained

The major difference between a Roth IRA and a traditional IRA is how tax is handled. One of the main advantages of a Roth IRA is that withdrawals are tax-free and penalty-free if drawn after you turn 59 ½. Its con is that contributions are not tax-deductible (cannot write them off on your tax return). The tax break is postponed and enjoyed later on in life, at retirement. On the reverse, money contributed to a traditional IRA, or 401(k), is pretaxed dollars, yet withdrawals are taxed at the highest ordinary income rate.

What does pretax mean? Pretax is money taken from a paycheck before tax deductions. If you take home a $1,000 paycheck and contribute $100 to your 401(k), $100 will go into your account, and then the remaining $900 is taxed. You’re lowering how much of your income you have to pay taxes on.

Disclosure: The Roth IRA offers tax deferral on any earnings in the account. Withdrawals from the account may be tax free, as long as they are considered qualified. Limitations and restrictions may apply. Withdrawals prior to age 59 ½ or prior to the account being opened for 5 years, whichever is later, may result in a 10% IRS penalty tax. Future tax laws can change at any time and may impact the benefits of Roth IRAs. Their tax treatment may change.

Contribute to your 401(k)

A 401(k) is a retirement savings plan sponsored by an employer. It lets workers save and invest a piece of their paycheck before taxes are taken out, and the employer may make matching contributions to the plan. Taxes aren’t paid until the money is withdrawn from the account. 401(k) plans, named for the section of the tax code that governs them, arose during the 1980s as a supplement to pensions. As the cost of running pensions escalated, employers started replacing them with 401(k)s. While a 401(k)can help you save, it has plenty of restrictions and caveats. In most cases, you can’t tap into your employer’s contributions immediately.

So, how much should you contribute? As much as possible, being mindful that you’ll need to have enough money to live, eat and pay down any debt you have. And don’t forget about your Bucket Strategy for saving(make sure you have an emergency fund and an intermediate fund set up too)! At the very least, invest enough to get the full matching amount that your company pays to match your contributions. You don’t want to leave free cash on the table. Let’s say your company offers a 3% match; here is how that would work. If you put in 3% of your $50,000 salary, or $1,500, your company puts another $1,500 in the pot. You can add more than that $1,500 yourself, but the company won’t match beyond 3%. The rules for matching funds vary, so be sure to check with your employer about qualifying for its contributions.

Disclosure: A 401(k) plan is a qualified employer-established plan to which eligible employees may make salary deferral (salary reduction) contributions on a post-tax and/or pretax basis. Employers offering a 401(k) plan may make matching or non-elective contributions to the plan on behalf of eligible employees and may also add a profit-sharing feature to the plan. Earnings in a 401(k) plan accrue on a tax-deferred basis.

Announcing Toujours Worth!

magine investing for your future with an automated investment platform that combines 24/7 sophisticated technology with access to a financial advisor team. Too good to be true? Now add in a personal investment plan for less than you’d pay for traditional advisory services, with online access so you can stay informed. Now imagine this plan changes and adapts as your life changes.

Dustin R. Granger, CERTIFIED FINANCIAL PLANNER™ and the rest of the Toujours team are proud to present Toujours Worth, coming in 2018! Whether you are a tech-savvy millennial looking to start building wealth or just cost conscience but still want some guidance, this program is designed for you!

Disclosure: Guided Wealth Portfolios (GWP) is a centrally managed, algorithm-based, investment program sponsored by LPL Financial LLC (LPL). GWP uses proprietary, automated, computer algorithms of FutureAdvisor to generate investment recommendations based upon model portfolios constructed by LPL. FutureAdvisor and LPL are nonaffiliated entities. If you are receiving advisory services in GWP from a separately registered investment advisor firm other than LPL or FutureAdvisor, LPL and FutureAdvisor are not affiliates of such advisor. Both LPL and FutureAdvisor are investment advisors registered with the U.S. Securities and Exchange Commission, and LPL is also a Member FINRA/SIPC. All investing involves risk including loss of principal. No strategy assures success or protects against loss. There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.

Outline of This Episode [2:15] Dustin R. Granger, CFP® on retirement accounts [4:15] Legal Disclaimer [5:30] The History of retirement accounts [8:15] Individual Retirement Accounts (IRA) [11:00] The Traditional IRA explained [14:15] The Roth IRA explained [19:15] Dustin R. Granger, CFP® gives IRA advice [20:30] Your 401(k) explained [26:45] What to do f you don’t have access to a 401(k) [27:30] ROTH 401(k) [30:00] How to prioritize retirement accounts [35:45] Introducing Toujour Worth© - Guided Wealth Portfolios [39:15] Toujour Worth© disclaimer Resources & People Mentioned dustinanddanielle.com/worth Connect With Danielle and Dustin Ask your questions! On Facebook On Twitter Connect with Dustin on Twitter: @DRGranger