Planting the Seeds for Your Retirement: Should you Choose a Traditional or Roth Account?

Mar 28, 2022 | Financial Planning, Getting Started, Nearing & In Retirement

Spring is here and those of us with a green thumb are deciding what to plant in the garden this year. Planning what you want your garden to look like in the future will determine which seeds you plant in the ground today. Similarly, planning what you want your retirement to look like in the future will determine how you save and invest today. Whether you are investing in a retirement plan through work such as a 401(k) or 403(b), or an Individual Retirement Account (IRA), there are two main varieties of retirement accounts to choose: Traditional (pre-tax contributions) and Roth (post-tax contributions). Choosing between a Traditional and Roth retirement account comes down to one major decision: when you prefer to pay taxes. Here is a breakdown of the unique characteristics of each account.

Traditional Retirement Accounts: 401(k), 403(b), or IRA

  • In most situations, the contributions you make into a Traditional retirement account are deducted from your annual income, giving you an immediate tax benefit.
  • Withdrawals from your Traditional retirement account after you are 59 ½ years-old are taxed as ordinary income. 
  • Withdrawals before 59 ½ years-old, with a few exceptions, are taxed at ordinary income tax rates and are subject to an additional early withdrawal penalty of 10%.
  • Starting at the age of 72, you must begin taking required minimum distributions (RMDs). This means you must withdraw a minimum amount from your retirement account, based upon the account value and your age, and pay the subsequent taxes on the amount you take out of the account.

Roth Retirement Accounts: 401(k), 403(b), or IRA

  • Contributions to a Roth account are made with income you have already paid taxes on, resulting in no income tax deduction. 
  • Any withdrawals you take from the account after you are 59 ½ years-old, and after five years since your first Roth contribution, are tax-free.  
  • You may withdraw any contributions to your Roth retirement account (contributions only, not growth and income) after five years without taxes or penalties, no matter your age. 
  • Balances in a Roth account are not subject to required minimum distributions (RMDs), meaning the money can stay inside your account for the remainder of your lifetime.

Additional Considerations

Back to the gardening analogy, your decision on what to plant is influenced by your local climate and environment, such as rain levels, temperatures, and soil conditions. Likewise, factors that are part of your personal environment, such as your current and future income tax brackets, retirement goals, and expected financial legacy are important to consider when choosing which type of retirement account to invest in. Considerations include:

  • Your Future Income: If you expect your income to be higher in retirement compared to now, you may want to consider Roth contributions rather than Traditional contributions.
  • Your Current Income: If you are a higher income individual, there are specific rules and restrictions that dictate how much you may contribute to retirement accounts and what you are allowed to deduct from your taxes. Understanding what plans you qualify for can avoid costly penalties or the headache of corrections. The IRS website provides detailed information at https://www.irs.gov/retirement-plans.
  • Windfalls: If you had a higher than usual income this year, you may benefit from a tax deduction now which a Traditional retirement account provides.
  • Legacy Planning: Due to a recent tax law change, most non-spouse beneficiaries are required to withdraw all assets from inherited retirement accounts within 10 years. Since the tax liability is passed to your beneficiaries, understanding the tax consequences is important. For example, if you plan to pass retirement assets to your heirs, a Roth could be helpful as the future withdraws would be tax-free compared to a Traditional retirement account, where withdrawals are fully taxable over those 10 years.

Retirement plans, whether Traditional or Roth, are powerful tools to help you reach your retirement goals. Ultimately, the responsibility of saving for your retirement is up to you. Recognizing what you qualify for, taking advantage of tax laws, and choosing what works best for your situation will help you grow strong roots for your future. Start planting the right variety of seeds for your retirement today. Talk to your GreenUp Wealth Advisor about which contribution makes sense for you.

Summary

GreenUp Wealth Management is a registered investment adviser.  Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies.  Investments involve risk and unless otherwise stated, are not guaranteed.  Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Past performance is not indicative of future performance.

Author

  • Tony Marquez, CFP®

    Senior Vice President | Wealth Advisor | Kansas City -- Tony is a Certified Financial Planner and has his master’s degree in Finance. Tony strives to be the expert, resource, and advocate that clients deserve when navigating a complex financial world. Prior to joining GreenUp Wealth Management in October of 2021, Tony worked as a Financial Advisor for a large financial services firm. There, he gained expertise in a variety of areas including financial planning, social security and retirement income strategies, college savings, and investment management.

    https://greenupwealth.com/meet-your-team/tony-marquez/ tony.marquez@greenupwealth.com Marquez, CFP® Tony

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