Taxes Now or Later?
This is the gist behind the two main versions of IRA and 401 (k) accounts. But since 401 (k) and similar style accounts, as well as IRAs, are now the lifeblood of our retirement savings, the decision to use a Roth or a traditional version of the account matters.
both traditional IRA and 401 (k) accounts offer savers the flexibility to make pre-tax contributions to their account as long as they fall below certain income limits. In the case of a 401 (k), this reduces taxable income upfront. Traditional IRA contributions to the account provide a deduction later when you file your taxes. Both accounts allow investments to grow and compound tax-deferred. With Uncle Sam offering tax savings now, he wants his piece of the pie later. This is when the traditional 401 (k) and IRA account holders will have to pay.
Distributions from a traditional account are subject to tax at the ordinary rate of income tax of the saver. This could reach 37% plus the additional 3.8% Medicare supplement. The kicker is that the IRS won’t let you compose your traditional account forever. The tax agency requires savers to take the minimum required distributions (RMD) from these accounts from age 72 and pay taxes on those amounts.
Roth 401 (k) and IRA accounts are a little different. Both accounts allow investors to contribute on an after-tax basis, that is, after the Fed takes taxes from your paycheck or after the money reaches your bank account. Since you’ve already paid taxes on the money, Uncle Sam won’t look for him later. As such, distributions from a Roth account are tax free. Much like a traditional account, Roth accounts allow you to combine growth with tax deferral.
But Roth accounts also have some drawbacks. On the one hand, not everyone can contribute. Income limits apply: Single tax filers must have an income of $ 140,000 or less, while married tax filers are capped at $ 208,000. Second, Roth 401 (k) are still subject to RMD; although the distributions are tax-free, investors are still required to make them or pay penalties.
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