You know you need to be socking away as much for retirement as you can. But are you putting it in the right type of account to maximize your investments? In part two of this episode you'll learn which type you should have and the right kinds of investments to hold in them.
Money Girl
174 MG Advice About Traditional and Roth IRAs, Part 2
You know you need to be socking away as much for retirement as you can. But are you putting it in the right type of account to maximize your investments? In part two of this episode you'll learn which type you should have and the right kinds of investments to hold in them.
- Broadcast on:
- 19 May 2010
- Audio Format:
- other
The new John Deere Gator SUV lets you cut, pack, drive, scout, weld, stack, feed, pull, load, tow, spray, and haul all in a single day. Because with the highest cargo box volume in its class, customizable features and a towing capacity of up to 4,000 pounds, it gets the job done. You just have to get in the seat. One more at your John Deere dealer or visit jondere.com/gatorxuv. Curious how equity compensation can help build employee financial confidence and move your business forward? Tune in to the latest episode of Morgan Stanley at Work's Invested at Work podcast where we explore the power of financial benefits and how they can help your employees in the workplace and beyond. Listen now by visiting morganstandley.com/investedatwork or stream on Apple or Spotify. Because we believe that when employees thrive, your company thrives too. Again, visit morganstandley.com/investedatwork to listen today. Hi, everyone, and welcome back to Money Girl's Quick and Dirty Tips for a richer life. I'm Laura Adams. My last podcast was an introduction to traditional and Roth IRAs. This week will go beyond the basics and I'll help you figure out something that lots of people get stuck on, whether you should invest in a traditional or a Roth IRA. First, here's a quick IRA review. If you have earned income or a spouse with earned income, you can contribute to a traditional IRA, to a Roth IRA, or to both. You can even max out a workplace retirement plan like a 401k and still contribute to either type of IRA as long as your total contributions don't exceed your allowable limit. If you're a high earner and have modified adjusted gross income above 120,000 or 177,000 if you're married in file a joint tax return, then you cannot contribute to a Roth IRA. If your income is too high, you can keep an existing Roth or even convert a traditional IRA into a Roth, but you're not allowed to make new contributions to the account or to fund a brand new Roth account. Okay, so if you're eligible to contribute to either a traditional or a Roth IRA, which one should you pick? I'll summarize the advantages of each one so you can see how they might apply to your situation. I also wrote about the disadvantages of each type, but I just put them on the blog at moneygirl.quickandertietips.com so we can keep the show from going too long. Let's start with four advantages of a traditional IRA. Number one, you save money on taxes the year you make contributions, unless you are a spouse also has a retirement plan at work. In that case, the tax deductibility of contributions is reduced if you reach certain income limits. Number two, you can defer taxes until a time when you expect to be in a lower tax bracket. If you believe that you'll learn substantially less money during retirement than you do now, then you might have a lower tax rate in the future. So paying less tax on your future withdrawals than on current contributions, as with a Roth, could make sense. If you're middle-aged or feel that your career earnings have peaked, it's possible that a traditional IRA will save you money on taxes. Number three, you have some flexibility about when you'll pay tax on your contributions and earnings with a traditional IRA. You can begin to take qualified withdrawals and of course pay tax on them beginning at age 59 and a half. Number four, you'll never have to worry about being taxed twice. Some speculate that the government could decide to tax all a portion of Roth IRA distributions in the future, even though taxes were already paid on contributions upfront. Since you only pay taxes on traditional IRA withdrawals and not on contributions, as with a Roth IRA, that may give you some peace of mind. Now, here are seven advantages of a Roth IRA. Number one, you bypass paying taxes on investments that appreciate in value or pay income. That becomes even more valuable to you if the capital gains tax escalates, which is slated to happen over the next few years. Number two, you can pay taxes now when your tax rate may be relatively low. Walmart Plus, it's Walmart Plus for your delivery, which saves members time plus money. Yep, plus an included Paramount Plus subscription to stream movies, show sports and that can't mean this documentary, plus Burger King savings. That's right, members get 25% off Burger King digital orders every day of the week. Walmart Plus, it's Walmart Plus. Become a member at walmartplus.com, $35 order minimum, Paramount Plus essential plan only, separate registration required, valid and participating USBKs and the BKF while bk.com remembers only. 25% off one time per calendar day, terms apply, see Walmart Plus terms and conditions. Earning your degree online doesn't mean you have to go about it alone. At Capella University, we're here to support you when you're ready. From enrollment counselors who get to know you and your goals, to academic coaches who can help you form a plan to stay on track, we care about your success and are dedicated to helping you pursue your goals. Going back to school is a big step, but having support at every step of your academic journey can make a big difference. Imagine your future differently at Capella.edu. Curious how equity compensation can help build employee financial confidence and move your business forward? Tune into the latest episode of Morgan Stanley at Work's Invested at Work podcast, where we explore the power of financial benefits and how they can help your employees in the workplace and beyond. Listen now by visiting morganstandley.com/investedatwork or stream on Apple or Spotify, because we believe that when employees thrive, your company thrives too. Again, visit morganstandley.com/investedatwork to listen today. If you believe that you'll earn more money during retirement than you do now, paying tax at a lower rate for Roth contributions instead of at a higher rate for traditional IRA withdrawals could make sense. If you're young or just starting your career, it's possible that your tax rate is lower now than it will be when you retire. 3. You can pass the account to your heirs instead of having to take mandatory distributions during your retirement. 4. You can withdraw your contributions without penalty at any time, as long as you've had the account for five years. However, withdrawing your earnings prematurely does trigger a 10% tax penalty. 5. You can also participate in a workplace retirement plan without any restrictions. 6. You'll have less taxable income during retirement since you're not taxed when you make withdrawals from a Roth. Having less taxable income may reduce the likelihood that you'll have to pay taxes on your Social Security benefits. 7. You can invest more on a post-tax basis than with a traditional IRA on a pre-tax basis. For example, a maximum $5,000 Roth contribution may be equivalent to a traditional contribution of 6,667, assuming a 25% tax rate. When you're trying to decide what investments to hold in your IRA, those that could potentially cost you the most in taxes are the best choices, like a dividend stock or a bond income fund. The taxes on the annual income will be deferred with a traditional IRA or eliminated with a Roth IRA. More tax-efficient investments, like a tax-free bond, should be owned in a non-retirement account. A major factor in the question about whether you should choose a traditional or Roth IRA depends on what the income tax rates will be in the future and how much money you'll make during retirement. I know, it's impossible to predict what's going to happen with government regulations and your income 10, 20, 30, or 40 years from now, so you simply have to take your best guess at it. If you prefer to have a bird in the hand and save money on taxes sooner rather than later, then the traditional IRA should appeal to you. But if you don't mind paying taxes in the current year, then the Roth has many advantages. And if you're still undecided, why not split your investments into both types of IRAs? To see how your investments would fare in each type of IRA, plug some numbers into the Roth vs. traditional IRA calculator at dinkytown.com. And a final quick and dirty tip is that if your employer matches your 401(k) contributions, you should always contribute enough to max out your workplace match before you contribute to an IRA. I hope you know that there are other ways to get more money tips, news, resources, and advice from me. Of course, there's the MoneyGirl Facebook page and my Twitter feed, but starting very soon you'll be able to get a weekly MoneyGirl newsletter with extra content that you won't find on the podcast or blog. Simply go to moneygirl.quickanddirtytips.com and hit the subscribe button that's located on the top right hand side of the page. I'm glad you're listening. Chachin! That's all for now. Courtesy of MoneyGirl, your guide to our richer life. Walmart Plus, it's Walmart Plus for your delivery, which saves members time plus money. Yep, plus an included Paramount Plus subscription to stream movies, shows, sports, and that can't miss documentary, plus Burger King savings. That's right, members get 25% off Burger King digital orders every day of the week. Walmart Plus. It's Walmart Plus. Become a member at walmartplus.com, $35 order minimum. Paramount Plus, essential plan only, separate registration required. Valid in participating USBKs in the BKF or BK.com for members only, 25% off one time per calendar day. Terms apply. See Walmart Plus Terms and Conditions. Curious how equity compensation can help build employee financial confidence and move your business forward? Tune in to the latest episode of Morgan Stanley at Work's Invested at Work podcast, where we explore the power of financial benefits and how they can help your employees in the workplace and beyond. Listen now by visiting morganstandley.com/investedatwork or stream on Apple or Spotify, because we believe that when employees thrive, your company thrives too. Again, visit morganstandley.com/investedatwork to listen today. [BLANK_AUDIO]