By Patrick Sochacki
This week, we have the pleasure of discussing retirement accounts! Many people I talk to don’t want to think about retirement or saving for the golden years.
This train of thought is dangerous.
Investing in yourself for your future can never start too soon. For this issue, we will be covering the difference between a Roth IRA and a traditional 401k.
An employer-sponsored traditional 401k has a maximum contribution of $19,000 a year and any contributions can be written off when you file your taxes.
Some employers will offer a matching 401k plan. This means that for every dollar you contribute up to a specific percentage of your paycheck, the employer will add that same amount of money to the 401k for free.
If you work somewhere that offers an employer matching 401k, then contribute the maximum so you can take full advantage of that free money.
You can start withdrawing payments of this money at 59.5 years old and are forced to start withdrawing at 70.5.
Now for the Roth IRA. You can open this retirement account yourself and it allows you to contribute up to $6,000 per year. You can withdraw any of the money you’ve contributed to the account, from the account, without paying any fees or penalties on the withdrawal. This provides lots of flexibility, should you suffer an emergency or have a massive unexpected expense.
You can start withdrawing payments at 59.5 without paying any taxes on the tens-of-thousands of dollars of growth and compound interest you will have gained over the decades of contribution.
With both accounts, there is a catch. If you withdraw any money at all from your 401k before 59.5 then you must pay a 10 percent fee on the money withdrawn, along with paying regular income taxes again.
Although you can withdraw the principal from your Roth IRA with no penalties, if you withdraw any gains then you must pay the same penalties as the 401k withdrawals.
Which account type is right for you?
The 401k is best if you are currently in a higher tax bracket and expect to retire in a lower tax bracket. The primary problem with this option is that we cannot predict what future tax rates will be, as they are constantly up for debate on the political stage and could be much higher in the future. This option is also somewhat limited, as you need an employer that allows you to contribute directly from your paycheck into the account.
The Roth IRA is best if you are in a lower tax bracket and paying the taxes up front makes more fiscal sense than paying them in the future, when you will perceivably be in a higher tax bracket. This option is useful if you intend to work and make money for your entire life and will be using retirement accounts as supplemental income on top of whatever you’re doing in the future. You can also set this account up yourself without employer involvement.
I know this is a lot to digest. Retirement is something that we must start thinking about now as no one is going to do it for us.
Stay tuned next issue for when I go over opening a personal brokerage account and how to start trading options.
