Traditional and Roth IRAs

Charles Schwab2023-11-04

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💫 Short Summary

The video discusses the differences between traditional and Roth IRAs, focusing on tax benefits and withdrawal considerations. Traditional IRAs offer tax deductions on contributions but require taxes on withdrawals, while Roth IRAs do not provide tax deductions upfront but allow tax-free withdrawals after five years. It is suggested to contribute to both types of accounts to maximize tax savings and flexibility. Factors like age, career stage, and future financial needs should be considered when deciding between traditional and Roth IRAs. It is important to check IRS income limits and seek advice from a tax professional to make informed decisions for a stable financial future.

✨ Highlights

📊 Transcript

✦

Differences between Traditional and Roth IRAs.

01:45

Traditional IRAs offer tax deductions on contributions but taxes on withdrawals, while Roth IRAs do not provide upfront tax deductions but allow tax-free withdrawals after five years.

The choice between the two depends on future tax rate predictions and access to funds before retirement.

Experts recommend contributing to both types of accounts for maximum tax savings and flexibility.

Factors like age, career stage, and future financial needs should be considered when deciding between traditional and Roth IRAs.

✦

Maximizing Retirement Savings Through Tax-Advantaged Accounts.

04:28

Contributions to retirement accounts may not be tax deductible, and some investors may earn too much to contribute to a Roth IRA.

It's essential to check the IRS's income limits and seek advice from a tax professional.

Both traditional and Roth retirement accounts offer tax benefits to maximize retirement savings.

The key is to contribute regularly and early to secure a stable financial future.

00:00If you're saving for retirement, IRAs, also known as Individual Retirement Accounts, can

00:07offer significant tax advantages.

00:10This video focuses on how to choose between two common types of IRAs: traditional and

00:15Roth.

00:16Each provides different tax benefits.

00:19In a taxable investment account, you have to pay taxes annually on most investment income

00:24and gains on investments you sell, which can slow the growth of the account.

00:29A benefit of both traditional and Roth IRAs is that your investment income and any gains

00:36if you actively trade or sell a security aren't taxed while they're in your account, which

00:41can help your investments compound.

00:44Where traditional and Roth IRAs differ is when you get tax breaks.

00:48You essentially have a choice of receiving a tax deduction now or tax-free withdrawals

00:54later.

00:55Let me explain.

00:56With a traditional IRA, your contributions may be tax deductible.

01:00This means you may get a tax break in the years you contribute to the account.

01:05But you still have to pay taxes sometime.

01:08With a traditional IRA, you pay taxes on money you withdraw.

01:13Essentially, choosing a traditional IRA means you'll pay taxes when you take withdrawals,

01:19but you may get a tax deduction now.

01:21Ok, so let's talk about Roth accounts.

01:24With a Roth IRA, contributions are not tax deductible, meaning you don't get a tax break

01:30when you make contributions.

01:32Once you contribute money to a Roth IRA, you won't have to pay taxes on your withdrawals

01:37as long as you've held that account for five years.

01:41So, choosing a Roth account means getting a tax break later.

01:45So, which one is better?

01:47It depends.

01:48Based on your personal circumstances, it's possible that one type of account might be

01:53better for you.

01:54The biggest factor is whether you think your tax rate during retirement will be higher

02:00or lower than your tax rate during the years you're contributing.

02:04If you think your taxes are higher now than they'll be when you retire, a traditional

02:10IRA might be better.

02:11For example, by retirement, your mortgage might be paid off or maybe your kids will

02:17be out of the house, so you'll need less income.

02:20With this lowered income during retirement, your tax rate may be lower.

02:25A traditional IRA would allow you to pay taxes when you take withdrawals and take advantage

02:31of the lower tax rate rather than paying your higher tax rate now.

02:35On the other hand, a Roth IRA may be the best choice if you think your tax rate could be

02:41higher when you take withdrawals, often during retirement.

02:45For example, if you're a young investor who's just starting a career, you may expect to

02:50pay higher taxes later in your career and into retirement.

02:54By choosing to pay taxes now at a lower tax rate, you may benefit by paying less than

03:00you would in retirement.

03:02Plus, you'll have the comfort of knowing you'll be unburdened by taxes when you withdraw from

03:07your Roth IRA during retirement.

03:10However, there are a few things to remember.

03:13First, it can be very difficult to predict future tax rates.

03:18As a result, many experts recommend contributing to both a traditional and a Roth account as

03:24a way to spread out your tax savings.

03:27Second, if you think you'll need access to money in your IRA before you retire, a Roth

03:34IRA may be a better choice.

03:36With a Roth IRA, you're able to withdraw your contributions at any time—though if you

03:42withdraw earnings on those contributions, they may be subject to income taxes and penalties.

03:49But with a traditional IRA, many withdrawals prior to age 59 and a half are subject to

03:55a penalty and taxes.

03:58However, some withdrawals for things like higher education, medical expenses, or the

04:04purchase of a first home might not be penalized in certain circumstances.

04:09Third, there are limits on IRA eligibility and tax benefits.

04:14For example, if you already have a retirement plan through your employer, traditional IRA

04:20contributions may not be tax deductible.

04:23And some investors may make too much money to contribute to a Roth IRA.

04:28Be sure to check the IRS's income limits and consult a tax professional.

04:33While it can be hard to predict your future tax rate, both traditional and Roth retirement

04:39accounts can help you maximize your retirement savings with tax benefits.

04:44The most important thing is to contribute early and often.

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