Roth vs Traditional IRA and How You Get the Best of Both

Updated : Oct 24, 2019 in Articles

Roth vs Traditional IRA and How You Get the Best of Both


Most Americans are losing $90,000 because
they don’t know the benefits of an IRA or the differences between a Roth vs traditional
IRA account. In this video, I’ll not only show you how
to decide between these two types of retirement investments, I’ll reveal a strategy to get
the best of both. We’re talking retirement plans explained
today on Let’s Talk Money! Beat debt. Make money. Make your money work for you. Creating the financial future you deserve. Let’s Talk Money. Joseph Hogue with the Let’s Talk Money channel
here on YouTube. I want to send a special shout out to everyone
in the community, thank you for taking a little of your time to be here today. If you’re not part of the community yet,
just click that little red subscribe button. It’s free and you’ll never miss an episode. So here’s a question for you. How many hours a week, a month do you spend
thinking about your investments? Thinking about how to get a higher return,
about how much you need or will have by the time you retire? If you’re like most people, it’s at least
a few hours a month…or a lot more for some of us. But there’s a good chance you’re missing
out on one of the best opportunities to make that extra return, to earn $90,000 or more
extra on your portfolio, and all without having to do anything more than you’re already
doing. We’re going to be talking about individual
retirement accounts, IRAs and their cousin the Roth IRA in today’s video and this could
be the most important video on investing you ever watch. The Federal Reserve reports that just one-in-three
households invests in an IRA. That means nearly 80 million families not
taking advantage of this opportunity. Beyond that, Fidelity reports that the people
that are investing in an IRA, are only contributing an average of $4,150 a year, well below the
maximum and missing out on some big benefits. So I don’t want to oversell this, I want
to get to some IRA basics, the differences between a Roth versus traditional IRA and
then a strategy to get the best of both worlds. I do want to share this graphic though, this
shows the value of a $500 monthly investment over 30 years in an IRA account versus in
a regular taxable account. Now we’ll get into why these numbers are
but look at that, if there was any doubt as to the power of IRA investing, look at that
$90,000 difference. Now let’s get to how you collect that ninety-grand! We’ll look at the basics of an IRA and a
Roth, the average amount people have invested by age and the big differences between these
two investment accounts. I’ll then show you how to decide which to
use and a strategy to get the best from each. So an individual retirement account, an IRA,
is a special investing account you set up and you can set these up on almost any online
investing platform. It literally takes no extra time to set these
up. When you’re opening an account or opening
another on the same site, it’s going to ask if you want it to be an individual taxable
account or an IRA so you just click the IRA box and that’s it. There are two types of IRAs, the traditional
which is just referred to as an IRA and a Roth account. We’ll go into more detail on the differences
and when to use each but it’s basically when you pay taxes. When you put money in an IRA, you take that
amount off your income when filing taxes so that’s an instant tax break. Even if you’re in the 10% tax bracket, that’s
saving you $600 every year from not having to pay taxes on that income. When you take that money out of your IRA in
retirement, you pay normal income taxes on everything you take out. So here you’re paying the income tax rate
on what you paid in and the returns over the years. Now compare that with a Roth IRA. With a Roth, you don’t get that instant
tax break. You invest in your Roth IRA but don’t take
that money off your taxes. Here’s the sweetness though. When you take that money out in retirement,
you pay nothing. You already paid taxes on the amount you invested,
so there’s nothing to pay there, but you also don’t have to pay taxes on the money
you made in the account. That’s huge and something most people don’t
realize about Roth IRA accounts. You never pay taxes on money you made on the
investments. Yeah, it’s nice getting that instant tax
break with a traditional IRA but you’re still paying taxes on the contributions AND
returns eventually. You get tax-free returns with a Roth. It’s one of the reasons I say every investor
needs some money in a Roth account. There are a few basics here I want you to
see then we’ll get to the average people have in their IRA by age, some of those important
differences between the Roth and IRA and how to use both. You can invest a maximum of $6,000 a year
into your IRA accounts and this is total. So if you have multiple IRA accounts, both
Roth and traditional IRA, and on multiple websites, you can only contribute $6,000 total
into all of them combined. If you’re age 50 or older, the government
allows you to invest up to $7,000 a year called a catch-up contribution. Now that money you invest in an IRA is locked
up until age 59 and a half. You control the investments but can’t take
the money out without paying a penalty and taxes owed. We’ll talk more about this in a bit but
I’m going to show you why it really shouldn’t be a problem. The deadline for contributing to your IRA
is the April after the tax year and this is a big benefit of IRAs. This means you can invest into an IRA by April
2020 to get the tax break for 2019. That’s going to allow you to do some tax
planning, figure out whether you want that instant tax break this year or in the future. I’m all about that company match on 401K
plans, that’s free money, but IRAs have some big advantages over a 401K. Since this is your own account you opened
and control, you never have to worry about leaving your employer and what to do with
your money. IRAs give you more flexibility to invest in
stocks, bonds, real estate…basically anything you want versus being trapped into a package
of funds in your 401K. IRAs are also less expensive by far compared
to all the fees you pay in a 401K. Despite all these benefits, only about a third
of American households invest in an IRA account. Of those that invest, most aren’t maxing
out that $6,000 contribution each year. We see the average IRA balance by age here. So an average around $20,000 for those in
their early 30s growing slowly to about $50,000 for those in their early 40s and $92,000 for
those in their early 50s. So let’s get the biggest complaint I hear
about IRAs out of the way. I know it sucks to have that money locked
up ‘til you’re 60 years old…but is it really an issue? Investors see that they can’t withdraw the
money and freak out but you know you need to be saving for retirement, right? What are you going to live off for 30 years
of your life? You going to be able to make it on the thirteen-hundred
a month from Social Security? Even while that money’s locked up, you still
control it. You can change the investments. You can move the money to a different IRA
account on a different website or into a different asset. There’s really no difference here between
your IRA money and the money you have saved in a taxable account for retirement. None…well except for that sweet tax break
on the IRA account. So before we get to the differences between
a Roth versus traditional IRA, I want to get your IRA questions. I truly believe these accounts are some of
the best investing you’ll ever do so I want to make more videos on the topic. But I need to know what questions you have
or suggestions for retirement investing videos so scroll down and tell me in the comments. What are your questions about IRA investing
or what video topics do you want to see in retirement investing? So even though these are both types of IRAs,
there are some differences between the Roth and traditional IRA you should know. We’ve already covered the difference in
taxes. With a Roth, you pay regular income taxes
but get to take all the money out tax-free. With an IRA, whatever you invest is taken
off your taxable income that year but then you pay taxes on everything you withdraw in
retirement. You can contribute to a Roth account at any
age even in retirement. For an IRA, you can only contribute up to
age 70 and a half years old. There are income limits to contributing into
a Roth account, if you make more than $137,000 as an individual or $200,000 filing jointly,
you aren’t allowed to contribute but I’m going to reveal a strategy to get around this
later. There’s no income limits to contributing
into a traditional IRA. Now if you do take some money out of an IRA
early and you don’t meet a few hardship circumstances, you’ll pay taxes on the money
plus a 10% penalty. So if you withdraw $2,000 from your IRA before
age 59 and a half, that money is added to your taxable income and taxed at your income
tax rate and you pay the 10% penalty or $200 on top of your taxes. Roth accounts are different though. You already paid taxes on the money you put
into the account. You can withdraw from your Roth up to the
amount you contributed even before you hit that 59 and a half. No taxes, no problem. Now if you withdraw from the earnings you
made on investments, you’ll be hit with the tax bill and 10% penalty. So the moral here is don’t touch your IRA
money because it’s hugely expensive if you do. One last difference here, with traditional
IRAs you’re required to start taking money out when you hit 70 and a half…and yeah,
I don’t know why everything is that half year, it’s completely stupid and takes longer
to say…but politicians I guess. Anyway, money in that IRA, you’re required
to take a certain percentage out each year after 70 and pay taxes on it. With a Roth IRA, no requirements. You could be 120 and still contributing or
not taking money out of your Roth. Now I want to show you how to choose between
the Roth versus traditional IRA and reveal a strategy to take advantage of both but let’s
recap the pros and cons here. With an IRA, you get the instant tax break
and that’s great for high income individuals that can save more on current taxes. I feel like IRAs give you more discipline
also since you can’t withdraw the contributions like with a Roth. The cons of course are that you eventually
pay taxes on everything, what you put in and your earnings, and you have the forced withdrawals
at 70. With a Roth IRA, you’ll never pay taxes
on returns. That deferred tax break is great for someone
not making much money now so someone that won’t get much from that immediate tax break
but the downside is that you’re paying taxes now on the contributions. But how do you choose between an IRA or a
Roth IRA? If you can only invest up to $6,000 a year,
how do you decide? The old school of thinking used to be to use
the one with the biggest tax break. So if you’re in a high tax bracket now but
maybe don’t expect to have as much income in retirement, you’d take that immediate
tax break and contribute into an IRA. On the other hand, if you aren’t making
much money now but expect to make more in the future, you contribute into a Roth IRA. You pay your taxes now at the lower rate and
then get tax-free income when your tax bracket is higher. The problem with this thinking is, first,
nobody knows what taxes will be like in the future. Not only do you not know how much money you’ll
be making but tax rates could be higher or lower so it’s tough deciding between the
immediate tax break or taking it in the future. Second though is that each of these retirement
accounts offer some great advantages and you don’t want to limit yourself to just one. Why not get an immediate tax break now AND
tax-free income in retirement? So I’ll get to that strategy on how to get
both but I want to cover one last question I get a lot about IRAs and that’s, “Can
I have multiple IRA or Roth IRA accounts?” Uh…yeah, I have five Roth and IRA accounts. I’ve got a Roth and an IRA account on ETrade. I’ve got a Roth on Ally Invest and an IRA
on M1 Finance and another account in a privately managed IRA I use to invest in alternative
assets. Not only do I get access to different types
of investments on different platforms; for example p2p loans, real estate and traditional
stocks. I take advantage of all the little freebies
and promotions like getting a $100 cash bonus for opening a new account. Now to that strategy for getting the most
out of Roth and traditional IRA accounts. First, it’s important to be strategic about
what you put into these. You want to focus on cash-paying investments
like bonds, dividends and real estate investment trusts when you’re investing in your IRA. Put these investments in a regular taxable
account and you’ll pay taxes every year on the dividends or interest you collect. Hold them in a retirement account though and
you’ll get those tax benefits. You won’t pay taxes for decades in an IRA
and you’ll never pay taxes on these cash payments into a Roth. Next is how to split your investment between
the two types of IRAs, Roth and Traditional, to get the best of both worlds. So you’re limited to that $6,000 contribution
each year. You can put it all in one type of account
or split it up. What I suggest is putting it all into a traditional
IRA each year. You get the max on that instant deduction. Then every few years, you do what’s called
a Roth conversion. This is where you take some of that money
in a traditional IRA and move it into a Roth account. There’s no limit to how much you transfer. So if you’ve been contributing that six
grand a year and you have $18,000 in your IRA, you can move $8,000 into a Roth and keep
the rest in the IRA, you can move it all into the Roth or however you want to split it up. Now you’re going to have to pay income tax
on this money you move over since you didn’t pay it when you contributed to your IRA, but
you won’t owe any penalties as long as it goes straight from one IRA to a Roth account. What this does is first it gets over that
income limit for high-income families. It’s also going to give you that tax flexibility
in retirement though. You’ll be able to withdraw tax-free money
from the Roth account and still get the instant tax-savings each year contributing to your
IRA. In retirement, you can plan each year to save
the most on taxes. In years where your income and tax rate is
higher, take a little less out of your IRA and more out of that tax-free Roth. Years where your tax rate is lower, take more
from the taxable IRA and let your Roth account grow. Click on the video to the right to see why
I love…and hate 401K plans. I share my strategy for getting free money
in a 401K and how to decide whether to invest in your company plan or an IRA account. Don’t forget to join the Let’s Talk Money
community by tapping that subscribe button and clicking the bell notification.

24 Comments

  • Does your company offer a 401K plan? See why I hate 😡…and love these free money investment plans and how to get the most from yours! https://youtu.be/XnF6D2CvogI

  • Can you do a video showing the steps after you fund your Roth IRA? I understand how to set up and fund it but then I fall flat. Thank you for all the valuable info!!!!

  • You explained retirement plans so fluidly. You deserve to be the highest paid teacher ✌️👌

  • You've mentioned that some securities like MLPs shouldn't go into a retirement account for tax advantage reasons. Do you recommend using a separate broker for these types of securities, or having two accounts with one broker?

  • Super valuable information. They should make this required watching in high school & college. Invest in an IRA/ROTH!

  • A few questions/thoughts:
    1.) Even if you have several IRA accounts (say you have 5 IRA accounts), you can only contribute up to the annual limit of $6000 (or $7000 for over level 50 folks) across all accounts (not $6000 per account), correct? This is what I gather from reading but no one answers it directly.
    2.) I have access to a traditional 401k and a Roth 401k at work. Both include low cost index funds from Fidelity of which I take advantage. I take advantage of the Roth 401k because of the higher limits but company match goes into traditional (I dont have a choice). The question, can I max out the Roth 401k ($19,000 for 2019) and have a Roth IRA with an additional $6000? My research says, yes. I know the withdrawal rules and RMD rules are different for Roth 401k vs Roth IRA – thoughts on those?
    3.) While I do take advantage of my 401k and IRA options, I HATE two things about both. The money is locked up (even a Roth IRA I cannot withdraw contributions for 5 years). I personally plan to retire early and so want the dividend/interest available for use/reinvestment. But the biggest thing I hate – everything is taxed at income rates instead of capital gains rates. So, especially for traditional IRA or 401k, I am getting a graduated tax rate at income tax levels which can really add up. I much prefer the 15% (or 20% depending) on my capital gains and dividends. Is there an argument or math that makes it work paying income tax rate? I suppose if your investments will yield less than what you make now – but thats not the goal!

    I feel like a mixture of both retirement and taxable accounts is the correct plan. But all I hear preached is MAX OUT YOUR RETIREMENT ACCOUNTS. Is that the best bang for your buck?

    Sorry, for the mental dump. Sometimes I have to think out loud.

  • My work place offer 401k with some percent matching but they do it through Securian. I notice that the same index fund expense ratio cost 1.12% while the same index fund if bought at Vanguard would only have expense ratio of .05%. I already got a Roth IRA with Vanguard but did 401K just to get the matching, after I leave workplace will roll over 401K into Roth IRA.

  • There appears to be something not quite right about your chart of taxable vs. IRA investing. I agree with the difference in the curves out to year 29, but upon liquidation in year 30 the drop in the IRA total wealth should be larger than from the taxable account. The taxable account should have capital gains which will be taxed at a lower rate than income. The IRA withdrawal will be fully taxable at the investor's income tax rate and both capital gains as well as reinvested dividends will be taxed.

  • Roth conversion ladders and withdrawing Roth deposits are both ways people in the FIRE community get their money early. Love the way you break these videos down. I think it would be cool if you divided this into age groups and how they should use these accounts!

  • Fidelity recently announced zero commissions, and you can earn a 1.58% monthly dividend on the money in your account while you determine what stocks, bonds, or reit's you want to buy.
    NO OTHER Broker gives this high of a dividend in your core account. Your core account is the money you use to fund your brokerage account. So your money is not just sitting there earning little or no interest while you decide what stocks, bonds, or reit's you want to buy. This is also great if you use the "sell and hold cash" from May to Oct strategy!

  • Thank-you for a very thorough overview of IRAs and Roths. Are there limits to the number of and the interval between Roth conversions that can be done each year? I believe the foreign dividend tax withholding is waived for foreign stocks held within a tax-advantaged account, but it depends on the tax treaty between the US and the foreign country. I wonder if you could address the tax implications of foreign stocks (ADRs) held in a US brokerage account in a future video.

  • Thanks to your videos I have a good idea of what dividend stocks are for me, thanks a lot. How about a video for top 5 asian dividend stocks?

  • Thank you Joseph, for this wonderful video. I'm a big fan of yours. My two questions are 1.that there is no income limit eligibility to contribute to traditional IRA correct? 2 is it true that we cannot claim a tax deduction if married filing jointly incone is =123k or for non working spouse married filing jointly= 202k when doing traditional IRA.

  • Fidelity is my one stop shop. My 401k has been there for years. They sponsor the Delaware 529 plan I use. I also have a Roth with them. They have the industry's ONLY 0 expense ratio mutual funds. Their cash management account couldn't be better. Free bill pay. No ATM fees. No annual fees except on the 401k plan, but they are micro small. My company's 401k plan allows me to manage 95% of the contributions, allowing me allocate my capital my way while further reducing management fees. The screener tool is decent. Customer service is on point every time, chat or phone. I like the web interface. Now there's $0 trade commission on domestic stocks and ETFs. For me and my needs, #Fidelity just works. However, shop around and see what may work better for you.

  • In my opinion I feel that it may be better to use a Roth IRA if your younger. I am 15 and have a part time job after school and I think Roth would be better now only because I am obviously in a lower tax bracket. It makes sense to pay taxes lower now rather then higher later

  • Why didn't you tell people how they can move there 401k into an IRA while they are still working?

    Disclaimer:** some companies won't keep matching you if you do this.

  • Good info and advice on how to leverage both. I like ROTHs because of how easy it is for the beneficiary to inherit w/o madatory distributions and inheritance tax. Are you familiar with self-directed IRAs that allow you to hold LLCs? If so can you talk about the pros and cons of this method of retirement investing?

  • Often overlooked is at tax time everyone qualifies for a personal deduction. So you can withdrawal that amount from an IRA and still pay no tax. The big question is how much do you need in your IRA to max this out every year? After you have that amount everything else to a ROTH? If so, what is a target amount at a given age to shoot for to stay on this track?

  • What do u know about putting ur money into a Roth 401k? Will u be able to take tax write off right away and then pay no taxes when u take the money out at retirement!

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