Roth IRA vs Traditional IRA vs 401K (SIMILARITIES & DIFFERENCES)

Updated : Sep 09, 2019 in Articles

Roth IRA vs Traditional IRA vs 401K (SIMILARITIES & DIFFERENCES)


ROTH IRA, TRADITIONAL IRA, 401K….. ARE YOU TOTALLY CONFUSED BY ALL THESE TERMS AND ACRONYMS? WATCH THIS VIDEO FOR A SUPER BEGINNER-FRIENDLY EXPLANATION OF HOW THESE ACCOUNTS WORK AND THEIR DIFFERENCES, PROS & CONS. BY THE END OF THIS VIDEO YOU’LL KNOW WHICH ONE MAKES THE MOST SENSE FOR YOU OR IF YOU ALREADY HAVE SOMETHING OPEN, WHAT TO DO WITH IT. AND IF YOU WANT TO LEARN MORE ABOUT HOW TO GET STARTED INVESTING HIT THAT SUBSCRIBE BUTTON FOR NEW MONEY & INVESTING VIDEOS EVERY WEEK. So let’s get right into it. All 3 of these accounts are designed to help you save for retirement. That means they come with restrictions on when you can withdraw the money (so typically you have to wait til you’re 59.5 to start
spending it), but they also come with AMAZING tax benefits. If you don’t take advantage of the huge
tax breaks you get from having these accounts, you’re leaving tens of thousands of dollars on the table! Back in the day, the Traditional IRA was the only type of IRA – hence the name Traditional. So if you contribute $6k to your Traditional IRA (which is the maximum allowed contribution in 2019), than you reduce your taxable income by $6k. That’s huge! That’s 30-40% TAXES on $6k that you DON’T have to pay. You know how you get a tax break when you donate to charity? It’s just like that, except that the money
is going to yourself, rather than to charity! So if you put away $6k into a Traditional
IRA every year, the tax savings are really gonna add up. That’s one benefit, but it doesn’t
end there. The investments in your Traditional IRA also get to grow tax-free. Outside of a retirement account, you typically have to pay capital gains taxes when your stock investments increase in value. Given that 94% of your retirement nest egg will come from stock market growth – investing inside a Traditional IRA is gonna save you
SO much money in taxes. First when the money goes in, saving you income taxes, and secondly when the money is growing and you don’t have to pay capital gains taxes. When you turn 59.5, you can start withdrawing money from it, but now those withdrawals actually will be taxable. So a Traditional IRA let’s you make tax-free contributions on the front end, but you don’t get to take tax-free withdrawals on the back end. If you want to find out about some other ways to reduce your taxes, then check out this video on tax loopholes right here. like Traditional IRAs. Now let’s talk about Roth IRAs. The only difference between a Roth IRA and a Traditional IRA is in the timing of the tax benefits. Remember how with Traditional IRAs, your contributions result in an immediate tax break that year? In a Roth IRA, you don’t get that. That’s because contributions to a Roth are after-tax. So here’s the good part with Roth IRAs. When you turn 59.5, you can start withdrawing money and it’s 100% tax-free. Yes girl, tax-free retirement income
for the rest of your life. Can I get a hell yes! Traditional IRAs give you a tax break upfront and no tax break in retirement. And
Roth IRAs instead of giving you the tax break upfront you get a permanent tax break in retirement So you can get a tax break now OR in the future… but not both. An easy way to think about it is that Traditional IRAs give you immediate gratification in the form of tax benefits today, while contributions to a Roth are a form of delayed gratification, because you have to wait until retirement to enjoy
the tax benefits. So now that you know the difference between Traditional and Roth IRA, how do you decide which? First of all, if you’re single and you make
over $122k, a Roth is not even an option for you. This also applies if you’re married and
together you make over $193k. Unlike Traditionals, Roth IRAs have income qualification limits. That’s because they’re so awesome. So obviously if you’re over the income limit, this is an easy decision for you because you’ll just have to go with the Traditional IRA! You can even have both, as long as you keep your total contributions to no more than $6k. Personally, I prefer Roth IRAs by a long shot. And I really think younger people, millennials like me, should really consider Roths over Traditional. I don’t know anyone who enjoys paying taxes
(if you do, then you’re weird) – and I love that with a Roth I can just pay taxes once
and never pay taxes on it again. The judgement call you have to make for yourself, is whether you think your tax rate will be lower or higher in the future. If it’s going to be higher, then it’s
better to just pay the taxes now with a Roth and never have to pay taxes later. If your tax rate is going to be lower when
you retire, then it’s better to pay the taxes later in retirement with a Traditional IRA. And if your tax rate stays the same, then
it doesn’t make a difference whether you go with the Traditional or the Roth. But think about it – it’s much more likely
that tax rates will be higher in the future, not lower? The U.S. government is currently $22 TRILLION in debt, And politicians keep introducing tax cuts
in order to get elected, so they’re just kicking the can down the road and one day we’re all going to have to pay for it in the form of higher taxes. So if you’re on the fence, I say go with
the Roth IRA, because even if taxes go up to 50, 60, 70% – you’ll have the security of a tax-free retirement. Now let’s talk about 401ks. A 401k is just a retirement plan that behaves just like the Traditional IRA, except that it’s sponsored by your employer. The best part about 401ks is the employer match. Most companies offer to match your 401k contributions dollar-for-dollar. It might also just be 50 cents for every dollar you put in, or even better. At my first job, the employer match was 3-for-1, so they gave $3 for every $1 that I contributed. I know – it was pretty amazing, and it’s
literally the main reason why I have a good-sized investment portfolio for someone my age. I mean employer 401k match is FREE money, so if your job offers it, you should ALWAYS always max that out. Period. Never say no to free money. So what’s the difference between 401ks and Traditional IRAs? Other than that they’re sponsored through your employer, also the contribution limits are much higher. As of 2019, you can contribute up to $19k
per year, and if combined with employer match, you can contribute up to a total of $56k per year. This means you can put a shitload of pre-tax money away for retirement. 401k plans are generally pretty limited in their investment options, whereas IRAs give you a lot more flexibility. You can’t really pick your own stocks in a 401k and you’ll probably only have a handful of index funds that you’re allowed to choose from. But with an IRA, you can invest in whatever stocks and bonds you want. you can buy and sell options, and you can even invest in real estate. So really anything is game with an IRA. In general, the ideal combination is to have a 401k and a Roth IRA. You can and should have both. You can have a 401k and a Traditional IRA, you can have a 401k and a Roth IRA, and you can even have all three, as long as you stay within the contribution limits. To learn more about how to actually invest the money in your retirement accounts, make sure you also check out these 2 videos here. And if you’re new to the channel, make sure to subscribe for new money & investing videos every week. Always remember to go after your dreams unapologetically, and to live life on your terms – cheers!

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