To Tax or Not To Tax

Thinking about saving for retirement with a 401k account but don't know whether you should do a "Roth IRA" or "Traditional IRA"? Well, let's start with understanding the main differences between the two types of IRA.

IRA (Individual Retirement Account) - is a retirement saving account that you will put money in and that money is invested into the stocks market in some way or form. People say that the average return on investment is 8%, but after fees and years of your money sitting in your account with all the up and downs in the market, it actually ends up being 5% return.  And then when you retire, you can withdraw money from your account.

"Traditional" - is usually an IRA with your employer that puts "pre-tax" money from your pay check into a savings account. The money you invest into this account will then have to remain in the account until you are 59 and a half years old, at which point when you withdraw any funds it will be taxed; federal and state tax. "Why 59 and a half?" Well at that age you will be at a lower percentage tax bracket (typically 15%-20%) than at an earlier age tax bracket (typical 30%-40%). If you do choose to withdraw money from your funds before the required age, then you will be penalized an early withdrawal fee of 10% and the Federal and state tax fee so you could be looking up to 40%-50% gone from years of savings.

"Roth" - is an IRA that can be set up with your employee or on your own that puts "taxed" dollars into an account. Unlike the Traditional IRA, the money you put into this account can be withdrawn whenever you want without being penalized. On the flip side, any money gained from interest has to remain in the account until you are 59 and a half at which point you will only have to pay a small banking percentage fee approximately 5-8%. If you do withdraw the money gaining interest, you will pay a 10% as well as a few additional fees.

So now you're probably wondering which one is better. Well, they both have their pros and cons, and based on your financial situation it may vary. Understand I'm not a professional banking adviser, but if you are first starting off, I recommend for everyone to split the 15% of savings (read Sticking With Your Budget to learn more) and put 7.5% in each. Having a savings account not easily accessible to your checking account makes your saving habits more strict, but in a case of a real emergency, you can withdraw your contribution from your Roth if need be.

Please let us know what you recommend or any feedback/questions you may have.


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