Types of IRAs (Traditional vs Roth)
Let’s talk about the types of IRAs and the differences between the traditional IRA and Roth IRA.
I’m passionate about investing in the stock market for retirement because it is one of the few democratic institutions in the United States. Anybody regardless of gender, race, age, can invest in it and grow their money over time literally by doing nothing.
But it is very important to understand how it works so that you can make decisions that are best for your situation.
An IRA is an Individual Retirement Account. It is a type of investment account that allows you to save for retirement by providing tax advantages. Anyone making taxable earned income that’s reported to the IRS can open an IRA. It is not dependent on an employer, like 401(k) accounts are. You can have both a 401(k) and an IRA.
The tax advantages vary according to the types of IRAs. I’m going to focus on the two most common ones – the traditional IRA and the Roth IRA.
In a traditional IRA, you contribute pre-tax dollars and pay taxes later in the future when you make withdrawals. Your gains will be taxed later, but you will get a tax deduction for the contributions of that year when you do your taxes. Check with your tax person on the specifics as they are best to advise here.
With a Roth IRA, you need to fall within the required income limit. If you make more than the income limit, you can still open an IRA and then do a backdoor Roth IRA.
In a Roth IRA, you contribute post-tax dollars and don’t have to pay taxes in the future when you start taking the money out. You get tax-free growth. You make earned income, pay taxes on it, and then put that money that’s been taxed already into the Roth IRA. Then it gets to grow and grow and you never pay taxes on it again.
So for a traditional IRA you get tax savings today, and with the Roth IRA, you get the tax savings later.
It really depends on your individual situation. For those in lower tax brackets and who are younger, a Roth might be a better idea. For those closer to retirement and in higher tax brackets, it might make more sense to stick with a traditional IRA.
I’m 32 and in a relatively low tax bracket, so I’m all about the Roth IRA. I would rather pay tax today and not have to worry about it in the future.
Being tax efficient may not seem like a big deal, but now that my money has been growing, I’m super happy that I won’t have to worry about paying any taxes when I’m enjoying my baller ass retirement.
Another perk of the Roth IRA is that you can take out your contributions once the account is more than five years old. So for example, if my Roth IRA is more than five years old and I put in $6,000 and I have a super dire emergency, I can take those six Gs back out again. I can’t take out any of the gains made on the account, but I could take out the money I put in with no penalty. You can do this at any age. The key is that the account must be at least five years old.
Have I taken out any of my Roth IRA contributions? Heck no! The value of tax-free growth is too important to me. I have an emergency fund in a high yield savings account set aside for emergency surprise expenses.
Whichever type of IRA you choose to open, the most important thing is to just get started.
There is no better time than today. By investing, you can outpace inflation and grow your money to make it work for you. Literally make money while you sleep. When I was working as a stockbroker, I saw how many casual millionaires there are in this country. They are ordinary people who have just been diligent about investing money for many, many years. You can be one of them!
Ready to learn more? I’ll walk you through all the details of opening and investing in both types of IRAs in my FREE investing workshop. Watch my investing in IRAs masterclass here!