Let’s be honest, retirement plans are not easy to understand no matter how much we attempt to simplify them. They are complex financial workings that require a lot of research and investing. Planning for the future can be intimidating for many individuals, saving for it can be a lot scarier!
According to the Social Security Administration, the average retirement benefit paid is only about $1,200 per month. Today’s life expectancy is more than 85 years old, and 34% of the workforce has no savings set aside specifically for retirement. There are a vast amount of retirement plans available, offered by a multitude of companies. However, before trying to understand the more complex plans, it is important to understand the most common type of plans. These can be simplified down to a Traditional IRA and a Roth IRA. A Roth IRA and Traditional IRA are both good retirement accounts to consider and offer many investment options that can help individuals plan for their future. However, there are several key differences to keep in mind when determining which account makes the most sense for your particular needs.
The first major difference is that a Roth IRA allows individuals to make after-tax contributions whereas a Traditional IRA allows for pre-tax contributions. A Roth IRA is better suited for individuals who expect to be in a higher tax bracket when they start making withdrawals. A Traditional IRA is better suited for individuals who expect to be in the same tax bracket when they start making withdrawals. So how do taxes factor into these plans? A Roth IRA does not provide immediate tax benefits since taxes are deferred and an individual will contribute their after-tax dollars. However, the money invested grows tax-free, and an individual can generally make tax- and penalty-free withdrawals after age 59½.
A Traditional IRA on the other hand differs because it provides individuals with immediate tax benefits as their contributions grow tax-deferred. It is also important to note that a Traditional IRA is subject to income limitations for participants in employer-sponsored plans. As mentioned above, Roth contributions come from after-tax dollars. As of 2022, individuals are allowed a maximum of $6,000, or $7,000 if the individual is over the age of 50 per deferral period (calendar year). There is contribution eligibility based on a certain level of income. In 2022, singles must have a modified adjusted gross income, or MAGI, of less than $144,000, with contributions being phased out starting with a MAGI of $125,000. However, there is no age contribution restriction.
A traditional IRA’s contributions come from pre or after-tax dollars with individuals also allowed a maximum of $6,000 or $7,000 if the individual is over 50, per deferral period.
Withdrawals are also very different for each of these plans as there are applicable restrictions to withdrawals. A Roth IRA offers penalty- and tax-free withdrawals after 5 years and age 59½. Whereas a Traditional IRA is penalty-free but taxed as current income after age 59½. There are also no mandatory distributions for Roth plans whereas a Traditional IRA has mandatory distributions for individuals after the age of 72.
Overall, each plan offers its own advantages and disadvantages but ultimately, it is up to the individual to decide what is best for their future. A clear way to narrow this information down is to decide whether you want to enjoy tax-free withdrawals in the future with a Roth IRA or take advantage of the tax benefits offered today by a traditional IRA. No matter what plan you decide is best for you, choosing the right professionals to aid along the way is also key. Whether it is a brokerage to manage your portfolio, or choosing a firm to help in the tax preparation, or providing an audit of the employer sponsored plan available. ADKF, PC is a perfect example that can aid in providing professional help with these stressful individuals and is with you all the way!