Saving for retirement is a financial goal for most clients. Many of us are familiar with the terminology but aren’t quite sure what it all means. Here is a brief summary of one major difference between a traditional IRA or 401(k) and a Roth IRA or 401(k).
Traditional IRAs are tax deferred meaning that contributions to those accounts are deductible when made. The amount contributed is deducted from your income and you won’t owe taxes on that amount. It also means that the dividends and sales of the stock are not taxed while they remain in the account. However when you start making withdrawals, the amount withdrawn is taxed. So the principal amount deposited and any increases due to ordinary interest, dividends, and capital gains are all taxed as ordinary income.
Contributions to a Roth account, on the other hand, are not tax deductible. Because taxes on the money deposited have already been paid, distributions from Roth accounts are tax-free and dividends, capital gains, and interest earned in the account are able to build tax-free. The beauty of a Roth IRA is that the Roth account holder will not pay taxes on account increases.
Each type of account has benefits and restrictions. The decision regarding whether to contribute to a traditional or Roth account depends in large part on your current tax bracket and estimation of when you will start making withdrawals.
Talk about the different options with your financial advisor. Learn more about both Roth IRAs and 401(k)s at https://www.irs.gov/retirement plans. And get started on the rest of your estate plan today by calling me at (949) 387-8707!