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The Best Retirement Account: Traditional vs. Roth

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Forge Your Wealth is meant for education and entertainment and should not be used for financial advice.

In today’s day and age, if you are looking for a good retirement account all you need to do is go to a financial expert and they will lay out many options. You would have better chances of finding nothing but terrible flavors at an ice cream shop than looking at a broker site and finding only terrible retirement accounts. However, when you go to an ice cream shop, you may find yourself overwhelmed with all of your options. The same happens at a broker, you have too many options. It is hard to determine what the best retirement account is for you.

Traditional IRA

A traditional IRA is a retirement account where the contributions are tax-deductible. However, the withdrawals are not. When you retire and withdraw from a traditional account the government will tax the withdrawals like regular income. Generally, you should aim to use this if you expect a lower income in the future than right now.

Roth IRA

For a Roth IRA, your contributions are not tax-deductible. So your contributions are from post tax income. However, unlike a traditional IRA, any withdrawals after 59.5 years of age are tax free, in addition to the Roth IRA being more than 5 years old. Generally, you should aim to use this if you expect a higher income in the future than right now.

401ks

A 401k is an employer based retirement account. It can work like a traditional IRA or a Roth IRA although Roth 401ks are harder to find. One of the main differences between a 401k plan and any other retirement plan is the employer match. An employer may match your contributions to a certain percent adding to your increase compared to the IRA equivalence. Or at least it would if there are small expense ratios, make sure to watch out for that.

So Which Retirement Account Is The Best Retirement Account?

In my opinion, the Roth IRA or Roth 401k accounts are the best retirement accounts. The reason for this is because of the tax benefits. While traditional IRA contributions are tax deductible, not only could the growth of money in the account be taxed from withdrawals, but the money from the contributions themselves could be taxed as regular income later. Keep in mind, if you invest in the S&P 500, you would have on average 7% return of investment, your initial investment would almost double every 10 years. So if you start investing at 25 and retire at 65, the investment would double 4 times. In other words, your money would increase by 16 times. If you invest $1,000, it could turn into $16,000 by the time you retire. The $16,000 your money has grown into can then be taxed as regular income. And all for a $1,000 tax deduction.

Meanwhile, if you invest your money in a Roth IRA, the money invested could grow very similarly without being taxed. Furthermore, there are fewer limitations on a Roth retirement account including required minimum distributions and an increased maximum age, something that required an important law to increase both of those for traditional IRAs and 401ks. And all you need to give up is the tax deduction.

The Best Advantage

Many retirement calculators ask how much you make with pre-tax income. Unfortunately, calculating how much you need in a balance using pre-tax income is misleading. Taxes are constantly changing. Furthermore, if you ever have an emergency and must withdraw more from your traditional account, you may be taxed more very suddenly. However, with a Roth account, you never have to worry about that. A Roth account balance is much more straight-forward than a traditional account balance so you will have no surprises with the value of your retirement account balance.

Final Thoughts

It is easy to discuss the benefits of finances by using a tax deductible traditional retirement accounts or tax free Roth retirement. But I think the mental benefits of how straight forward the Roth retirement accounts are will beat a traditional retirement account.

Of course a Roth retirement account is not for everyone. Literally, you must make less than $124,000 if filed single or less than $196,000 in adjusted gross income to qualify fully to contribute to a Roth account. That may sound like an amount of money you cannot reach, but truth is, if you invest while working with a salary that is more than modest, you may not be able to contribute into a Roth account for too long. But if you do qualify to contribute into a Roth retirement account, I highly recommend you invest into a Roth retirement account before you may not be capable of contributing anymore. Roth retirement accounts are almost the best tool you can have to forge your wealth.

Author: Papa Foxtrot

Most of my life I was careful with money and learned where I should invest it. I was very lucky to have parents who taught me financial literacy when I was young. Unfortunately, I am very lucky because many people lack the financial literacy I know. The purpose of Forge Your Wealth is to teach people who are just starting out in life how to obtain their wealth or anyone who just realized they may need to learn more to handle their finances. I currently have a PhD in biochemistry, just started a job in industry (will not disclose where exactly for personal and professional reasons) and am currently married to the love of my life. I am one of the lucky few people in America who graduated with no student debts, my wife was not. Over the series of a little over 3 years we paid for our wedding with no debt and paid off her federal student loans.

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