IRA VS ROTH IRA
Are you new to investing and feel lost in the myriad of choices and complexity? If that describes you, please watch the video below, and you should have a much better understanding of the two most common retirement accounts along with their pro’s and cons.
Let compounding be your friend and if you don’t believe me here’s a great Einstein quote.
“Compound interest is the eighth wonder of the world. He who understands it, earns it … he who doesn't … pays it.” Albert Einstein
Talk with a FocalPoint advisor today about starting your retirement plan. It’s easy and you’ll be glad you did when it’s time to retire.
Text Version of IRA VS Roth IRA
Hi Everyone I’m Tim Picciott, and I’m a Certified Financial Planner and Wealth Advisor at FocalPoint Wealth Management
Today I’m here to breakdown the differences between the traditional IRA and the Roth IRA.
One of the most common questions I’m asked is…
What is the difference between an IRA and a Roth IRA?
That is a very important question so I’d like to show you the main differences rather than just sit here and tell you the differences.
First, let’s start with the traditional IRA or IRA… which is short for individual retirement account.
I like using easy math so let’s assume you made $100,000 last year. If you maxed out your IRA, which is $5,500 for 2016 …. your income would go down by $5,500. All other things being equal your income would now be 94,500.
We did make a few assumptions, though.
We assumed you were single which would make your marginal tax bracket was 28%
Once we multiply $5500 by 28%, we find a current year tax savings of $ 1540 One thousand five-hundred and forty dollars.
Another important advantage of an IRA is that any future gains would continue to grow tax-free until you withdrew those funds.
Many people assume they will have a lower marginal tax rate in retirement that way they can withdraw those funds at let’s say a 15% tax bracket vs. their current 28% bracket. Again these are just assumptions and no-one has a definite way of knowing what their future tax rate will be.
Now moving on to a Roth IRA. The Roth gets its name from the Senator responsible for creating the Roth Ira and as you imagine his name has Roth in it. More specifically his name was William Roth of Delaware
Ok, so what is it?
Going back to our first example… Let’s assume we still made $100,000, but instead of contributing to a traditional IRA we wanted to contribute to a Roth.
So we put our $5500 into a Roth and now our $100,000 of taxable income became $100,000 of taxable income.
You’re probably wondering, well if my taxable income didn’t go down and I didn’t realize any current tax savings…. why would I want to invest in one of these?
Ok….So here is the reason. A Roth is investing after tax money … which means it isn’t taxed when you withdraw it:
provided you meet some basic conditions and there are special exemptions where you can withdraw your money early most notably your allowed to withdraw $10,000 to make a first-time home purchase.
Ok so let’s see the Roth IRA in action. Let’s take a 25-year-old millennial who invests $5500. First of all, this sounds like a very smart move but anyways.
The question becomes: would you rather pay taxes on the $5500 now or what would presumably be a much great sum when you are retired?
For instance that $5500 compounded at 8% per year would mean ….just that $5500 would be worth $119,485 at age 65!
Now if we kept investing 5500 per year until age 65 then the number is a staggering 1.658 million dollars?
Now this is not everything you need to know about IRA’s, but this is the most important information you need to know to help you make your decision between the two types of retirement accounts.
Generally speaking; the further away from retirement you are, and the less money will tilt the favor towards the Roth Ira
Conversely, if you are nearing retirement and or make a lot of money than a traditional Ira might make more sense.
For some people, if might make sense to have both.
I appreciate your time and if you have more questions feel free to email us at: email@example.com.
You can also call our office at 480-771-PLAN to schedule a free consultation.
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Thank you for watching and have a great day
Tim Picciott CFP® CRPC®