Steve Coker, CFP
Traditional or Roth: Retirement Savings Game Plan
When it comes to saving for retirement, there are a variety of ways to go about it. It’s always a good idea to start by evaluating retirement plans that are available to you through your place of employment. Often, employers will match your contributions, which is an easy way to essentially double your savings, not to mention, earn more from your work. When setting up your retirement plan you’ll be faced with several choices regarding when to start contributing, what type of account you should set up, and how much you should contribute.
In regards to the first choice, it’s never too early to start saving for retirement. Numerous studies have shown that establishing a habit of saving at an early age has a significant effect on wealth accumulation over a person’s lifetime. When you begin contributing; however, does impact what type of account you should contribute to.
There are essentially two types of Investment Retirement Plans (IRAs): Traditional and Roth. A traditional IRA is structured in such a way that you receive tax savings right now in the form of deductions for whatever you contribute, but have to pay taxes on a later date when you pull the money back out for retirement. In the meantime, your money grows tax deferred (meaning you don’t have to pay taxes on changes in the account value, in the interim). It is important to remember that once you contribute money to a traditional IRA, you can’t take it back out until you have reached retirement age (59.5 years), otherwise, you will be penalized and have to pay an extra 10% on the money you pull out in addition to regular taxes. A Roth IRA is an account that has been funded with after-tax money meaning you pay taxes on the money you contribute (with no deductions), but the money grows tax-free, essentially forever. To help you decide when to contribute to what, we’ve created a simple game plan that will guide you through retirement savings vehicles at various stages of life.
In your 20s
In your earliest working years, we recommend that you begin saving for retirement in a Roth account. This is because the assumption is that in your earliest earning years, you are making very little, thereby placing you in a low tax bracket. By saving into a Roth you take advantage of paying little taxes up front on money that will grow tax-free forever, assuming that by the time you retire you may be in a larger tax bracket. This allows you to pay lower taxes in your early years and avoid paying higher taxes in your later years.
In your 30s
As you earn more, you will slowly be pushed up into higher tax brackets, but your earnings may be offset by deductions for a mortgage or dependents if you choose to buy a house or have children. If at all possible, it is still a good idea to target Roth contributions first, but as your earnings increase you may be forced to switch to a traditional IRA due to the phase-out limits on Roth IRAs.
In your 40s
For most individuals, your 40s are when you begin to hit peak earning years. At this point, it is still best to contribute to a Roth, but in the event that you are no longer able to contribute to a Roth, you will need to open up a traditional IRA. The good news is that your contributions to your traditional IRA (up to a certain limit) are tax-deductible, which should help you save a little on your tax bill now that you are in a higher tax bracket.
In your 50s
At this point you are beginning to approach retirement and are likely contributing to a traditional IRA. Once you reach the age of 50 you also become eligible for what the IRS refers to as “catch-up contributions.” Catch up contributions are intended to help individuals “catch-up” on their retirement savings by contributing extra beyond the regular limit. Finally, once you reach age 59.5 you also become eligible to begin pulling money from your IRAs penalty free.
In your 60s
Once you reach retirement, depending on your situation, you may want to look into the possibility of converting some of your traditional IRA money into a Roth account. In doing so, you will have to pay the taxes, but after that, the Roth money will grow tax-free. This is often a good idea for individuals who have a variety of other income sources and are looking for some tax savings. Additionally, it’s important to remember that starting at age 70.5 you will be forced to take what are called Required Minimum Distributions or RMDs from your IRA accounts. Furthermore, once you reach age 70.5 you are no longer eligible to contribute to a traditional IRA; however, you may still contribute to a Roth.
The process of saving for retirement can seem daunting, but having a good game plan can make all the difference. To learn more about what type of account is right for you and to get help on creating a winning game plan, request a meeting with one of our knowledgeable advisors today.